Buy sell agreements are an essential element of succession planning. These agreements protect the future of a business by defining the rights and obligations of the co-owners in the event that one owner exits whether because of death, disability, retirement, the development of a dispute, or a simple desire to pursue new ventures. A well drafted buy/sell agreement should
 

  • define the triggers for the sale of an interest,
  • set the price,
  • establish a funding mechanism for the sale and
  • define tax treatment.

 
For expert planning and business legal advice on a buy/sell agreement, you and your co-owners should contact Owen Hodge Lawyers at 1800 770 780 or send us a message at https://www.owenhodge.com.au/contact/ to schedule a consultation.
 

What Events Might Trigger the Sale of an Interest in a Business?

 
Consider the awkward situation that would ensue if one of three business partners actively engaged in running a business died without a will. His interest in the business would be included in his estate and eventually distributed to his nephew when probate is complete. If a long process effectively prevented the other owners from running the business, the income stream to those dependent on it for a livelihood would be interrupted. The process could also leave the n’er-do-well nephew with control of a company he cares nothing about. Negotiating to buy out the recalcitrant nephew completes the ruin. Why would any businessperson do this to a carefully nurtured enterprise? A well-designed buy/sell agreement should define the events that would trigger the co-owners’ right, but not the obligation to buy back an existing owners interest in the business, termed a “call.” This might be appropriate where management has become deadlocked because of a dispute. The agreement would also define the event that would give an exiting owner the right, but not an obligation to compel the remaining owners to buy that interest, termed a “put”. This situation might arise when an owner wants to retire. Of course, buy/sell agreements need not be structured around put and call options. The agreement can simply provide that, upon the occurrence of some contingency, the business entity itself will acquire the exiting owner’s interest, or that upon this contingency, the entire business will be sold on the open market. In addition, for planning and financing purposes, it is important to consider whether the triggering events are voluntary or involuntary. Death and disability are involuntary. Retirement or the serial entrepreneur’s decision to move on to other ventures are voluntary events.
 

How Might We Set a Price for the Ownership Interest?

 
With SMEs, there often is no market for an interest in the business other than the co-owners, whose interest is, nonetheless, quite urgent. The existence of a buy/sell agreement allows the parties to set the price, or a formula under which the price will be determined in the future, which can take the strain out of a negotiation at a time when customers and clients are likely to require reassurance. There may be circumstances under which a price reduction would be appropriate, as when an owner is forced out for a variety of misdeeds, including violation of a shareholder’s agreement, or the commission of a crime. To the extent possible, the buy/sell agreement should describe these events, as well.
 

How Should the Remaining Owners Finance the Buy Back?

 
This is where the difference between voluntary events and involuntary events becomes important. The involuntary events may be insured against. The co-owners of a business, or the business itself, may insure the lives of the owners. On the death of an owner, the proceeds of the policy may be used to purchase the deceased owner’s interest in the business. Voluntary events, however, may not be insured against. Therefore the financing arrangements underpinning the buy/sell agreement usually take the form of some combination of insurance and other sources of capital. Those other sources may include borrowed funds or even vendor financing, the availability of which is less certain. Timing can also be an issue. Co-owners should consider whether a lump-sum or installment payments would be preferable and whether a promise to pay out over time should be secured in any way. Finally, it is important to consider who will own the exiting owner’s interest, whether it will be divided according to some formula among the remaining owners or whether it will be owned by the enterprise, itself. A third option, of course, would be to require that the entire business be sold on the occurrence of a named contingency. An experienced attorney should be an integral part of the planning process, especially since the design of the buy/sell agreement may have important tax consequences.
 

What About Capital Gains Tax?

 
In general, the event that causes Capital Gains Tax liability is not the execution of the Buy/Sell agreement, but its exercise. In the case of an installment sale, the tax liability may occur in one year, even though the acquisition of the business interests is spread over several, an unattractive arrangement for the buyer. In the best of all possible worlds, succession planning, including the execution of a buy/sell agreement should take place early in the life cycle of a business. Furthermore, this element of business planning should not take place in a vacuum. It may be very valuable, for example, to have an exiting owner sign a non-compete agreement. It may be important to review the provisions of individual estate plans at the same time. This kind of comprehensive business planning is also not necessarily a once-in-a-lifetime event, but should be revisited periodically to ensure that it continues to reflect the goals and current situation of the business. At Owen Hodge Lawyers, we offer the depth and range of experience you and your co-owners will need to ensure that all aspects of the plan have been considered. Call us today at 1800 770 780 to schedule a consultation. With offices conveniently located in Sydney and Hurstville, we look forward to meeting with you at your convenience.

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