Ownership interest in a closely held business often constitutes a significant part of a business owner’s overall wealth. For owners who are concerned about preserving the value of this business capital for themselves, and/or as a legacy for their families, a well-drafted buy sell agreement by and among all of the owners is important.
From a business’ inception up until implementation of a final exit strategy by the continuing owners, a buy sell agreement may be essential tool to help:
- Preserve the business’ long-term viability by preventing control from passing to unwelcome and potentially disruptive parties
- Ensure that each departing owner (or his or her estate) receives a fair price for his or her interest
- Establish a funding source for the purchase of each departing owner’s interest
Primary benefits of a buy sell agreement
Buy sell agreements have many benefits, one of the most important is to help current owners maintain control and to preserve the marketability of ownership interests.
Maintaining control by current owners
Over the long term, one of the greatest threats to preserving the viability of a closely-held entity is the risk of ownership interests passing to outsiders who will disrupt the smooth operation of the business. For example, the children of a deceased owner may acquire an ownership interest through inheritance, but elect not to take an active role in the business. This could lead to clashes between the children and the existing active owners on issues where their respective interests are not aligned—such as whether to distribute or reinvest profits. Under another possible scenario, the former spouse of an owner might acquire an ownership interest through a divorce proceeding, creating an uncomfortable and potentially unworkable operating environment for the existing owners.
In some cases, unrestricted transfers of ownership interests create legal and tax problems for the business. Certain types of entities, such as S Corporations and some professional services businesses, are required to limit their owners to enumerated permissible parties. In these situations, the transfer of an ownership interest to a prohibited party can result in adverse legal and/or tax consequences.
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