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Buy/sell agreements – do you need one?
What is a Buy/Sell agreement?
Generally speaking, a buy/sell agreement refers to a contract drawn up between business partners which will identify a set of ‘trigger events’ where all remaining business partners will buy out a partner’s interest and/or investment in the business. Key trigger events are the death or permanent disability of a business partner, but may also include events such as divorce, retirement, or bankruptcy.
If you’re wondering how these agreements work, or where the guarantee of available finance for the required buy-out comes from, that is a valid question. Often, a buy/sell agreement is specifically linked to the purchase of life insurance policies by business partners, for business partners. In this instance, where a business partner passes away or is permanently disabled, it is the life insurance payment which is used to buy-out the partner’s interest.
Who needs a Buy/Sell agreement?
A solid buy/sell agreement should be drawn up so the business ownership structure, such as a partnership versus a company, is irrelevant to the agreement.
Further to this, YML Group would recommend that anyone who owns a business with another individual should have a legally drafted buy/sell agreement in place to ensure continuous and smooth operational efficiency, regardless of circumstances which may affect one or more business partners.
How the agreement works
Where a business owner passes away, their share of the business can be dealt with in two main ways:
- Sale of the business through an existing buy/sell agreement
- Gift of the business through an existing will
Because a will must be dealt with by the estate, and wills are commonly contested, there is no guarantee that option two will allow the business to continue operations as usual while the estate is settled. In some situations, sale of the business in entirety may be forced to settle the estate, and fair market values are never guaranteed. In short, relying solely on a will may endanger the business as a whole. Because a buy/sell agreement is a contract, it has priority over an existing will and ensures the business is sold accordingly. Again, it is crucial to have this agreement legally drafted, as key parameters must be included for the execution of the contract.
A buy/sell agreement also prevents any potential disagreements between business partners in the event of disability, or other key trigger events.
Tax and Buy/Sell agreements
There are potential tax implications for a business when a trigger event occurs, and the buy/sell agreement comes into place. Much of this centres on the insurance payment that will likely fund the completion of the agreement. Should a buy/sell agreement result in the payout of a Life Insurance policy or a Total and Permanent Disability policy, there are specific situations where the payment is exempt from Capital Gains Tax. Your financial advisor can assist in setting up the buy/sell agreement and any subsequent insurance policies to best benefit the successful running of your business.
Talk to our Financial Planning department today to see how YML Group can assist you with drafting an appropriate Buy/Sell agreement for your business. Contact us on (02) 8383 4400 or by visiting the Contact Us Page