buy-sell agreement

3 Must Have Business Agreements

Barbara Weltman — Thu, 10 Mar 2011 22:19:13 +0000

Link:

http://www.openforum.com/idea-hub/topics/managing/article/3-must-have-business-a...

Hollywood movie mogul Samuel Goldwyn, founder of MGM, once said: “A verbal contract isn't worth the paper it's written on.” It’s a good idea for small business owners to put agreements in writing. Here are three agreements that you should definitely consider getting in writing.

Confidentiality Agreement

Your company many not have a secret formula as valuable as those used by Coca-Cola and KFC, but every company has some information that it does not want to become public. Whether customer lists and pricing information or new products and processes, you have valuable business secrets. To help protect that info, use a confidentiality agreement (also called a nondisclosure agreement).

A confidentiality agreement is a contract signed by your employees or any third parties with whom you intend to share confidential information. By signing the agreement, the employee or third party agrees not to share that information. For example, if you’re considering a joint venture with another company, you’ll likely need to divulge certain information about your business; make sure it remains confidential by having an agreement in place before you discuss it.

Find free sample confidentiality agreements at:

IPwatchdog.com (agreement for inventors)
MoreBusiness.com (agreement with third-parties)
oneCLE (employee agreement)

Buy-Sell Agreement

If you have co-owners in your business, it’s wise to decide what happens to an owner’s interest when he or she retires, dies, or just wants out. This can be settled by the terms of a buy-sell agreement.

The agreement can be constructed in several ways:

Cross-purchase agreement, in which the remaining owner or owners buy out the interest of the departing owner. This type of agreement works best if there are only two owners in a business; it gets cumbersome when multiple owners are involved.
Redemption agreement, in which the company buys back the interest of the departing owner. This type of agreement works best when there are several owners.
Hybrid agreement, which can include both a purchase and buyback.

The buy-sell agreement should be made when the company is started, but can be created at any time. Here are some features to include:

The type of buy-sell agreement (e.g., cross-purchase agreement);
A list of triggering events, such as retirement, disability, personal bankruptcy, divorce, or death;
A mechanism to determine the value of the departing owner’s interest. This can be a formula clause in the agreement, a requirement that an appraisal be obtained at the time of the triggering event, or some other method. It’s usually not a good idea to set a fixed value in the agreement because it may not reflect changes in value by the time of the triggering event;
The funding that will be used to pay for the buyout. Life insurance usually is used for buyouts at death; other funds must be used for buyouts for other triggering events.

Find free sample buy-sell agreements at:

DocStoc (for limited liability companies)
Jian.com (for corporations)
Meg Financial (for corporations)

Independent Contractor Agreement

Many businesses hire contractors as a way to lower operating costs while still getting things done. The problem is that the IRS and the states will look at how you classify your workers, and if it’s determined that your contractors are really employees, you are liable for payroll taxes, employee benefits, workers compensation, and unemployment coverage for them, too.

Worker classification is primarily based on the degree of control you exercise over the workers. One factor in determining control is the relationship of the parties. If you and the workers agree up front that the relationship involves independent contractors and is not an employer-employee relationship, this helps to avoid reclassification of workers as employees. A good way to show the relationship is with an independent contractor agreement.

The agreement should include the following points:

A statement about the relationship of the parties;
A statement that the worker acknowledges responsibility for taxes and insurance;
Language bolstering independent contractor status, such as that the worker is required to furnish his/her own tools.

While the agreement is not binding on the IRS, it can help demonstrate worker classification if the IRS has questions.

Find free sample independent contractor agreements at:

Bottom Line

While sample agreements may be useful in getting ideas for your situation, it is highly advisable to have any agreement you prepare reviewed by your attorney. Your attorney can tailor your agreement to your company’s specific needs and make sure it complies with the laws in your state.

This article is from Barbara Weltman of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Business Succession Planning Part 3: Using Disability Insurance to Protect your Business Interest

Nora Dunn — Fri, 15 Feb 2008 01:30:23 +0000

In my previous posts on this topic, I delved into the world of Buy-Sell Agreements, and how to use Life Insurance to fund these agreements and insure valuable assets like key employees.

But there is a risk much more prevalent than death which also needs attention on the part of business owners and partners: the risk of Disability.

In our working lives, we are considerably more likely to become ill or injured such that we cannot work than we are to get proverbially hit by a bus and killed. So it can be argued that even more important than the need to insure our lives is the need to insure our ability to work.

There are a few ways in which business owners might consider covering off a Disability:

Buy-Sell Agreement Funding

Disability Insurance

Bob, Joe, and Dave run a successful widget business together as partners. As such, they have done their due diligence in putting together a buy-sell agreement (also known as a shareholder's agreement) in order to protect both their respective shares of the business as well as the company as a whole.

One of the clauses of the agreement surrounds disability. See, if Joe becomes disabled such that he can't do his job (which happens), then Bob and Dave have to pick up the slack. Joe might have his own personal DI policy which protects his salaried income. (However if he is paid with bonuses and dividends, he won't even qualify for a personal DI policy - that's another can of worms entirely). Either way, for a few years Bob & Dave can probably keep the company above water for the time that Joe needs to recuperate.

But if Joe's disability is long term or "permanent" in nature, the company has a whole new set of issues on its hands. Joe is no longer contributing to the success, growth, and maintenance of the company due to his disability. Should he rightfully continue to remain an owner, reaping the benefits of a business that is growing independent of his own efforts? Or is it time for Joe's share to be bought out so Bob & Dave can move on with the business, or take on another partner? (Again, Joe should have a personal DI policy, so it's not like he is being left in the dust if he's planned properly for himself).

Assuming the three of them agree, standard buy-sell agreements usually state that after a partner is disabled for "x" amount of time (usually a year), and/or if it is determined that the disability is permanent in nature, the disabled person's shares are to be purchased by the other owners or sold back to the company.

Most companies and business owners don't have the money kicking around to pay for such things, especially as the company grows and prospers over time and the amount required to buy out an owner becomes substantial. There is however a solution: to fund the agreement with a special type of Buy-Sell Disability Insurance.

The premise of Buy-Sell DI is to comply directly with the terms of the buy-sell agreement. In fact, the insurance company may require a copy of the agreement to process the application.

One of the easiest ways to implement this arrangement is to have cross-owned policies. Bob & Dave personally own a policy for Joe. Joe & Dave own for Bob, and Bob & Joe own one for Dave. It works best for partnerships of only two or three owners; more than three partners, and the cross-ownership strategy gets a little too complicated.

Once Joe has been disabled for 1 year (for example), the agreement states that his share of the business is to be bought out either in a lump sum or over a period of 2 years. The DI policy is structured to pay Bob & Dave exactly the money required to satisfy the terms of this agreement to the letter.

You can also structure this policy so the company owns it and is the beneficiary of the cash to pay out Joe, however taxation issues become a little more prevalent in this case (depending on the corporate structure).

Critical Illness

Critical Illness insurance (you can get the basics about it here) is another way to comply with the terms of a buy-sell agreement. CI usually pays out a lump sum of money in the event of a diagnosis of a critical illness. Since most buy-sell agreements stipulate a lump sum purchase of the disabled person's share of the business, this might be a good solution. It also usually costs less than corresponding DI policies, so is great for the budget-minded business owner.

Another benefit is that qualifying for CI has nothing to do with income history; whereas buy-sell DI requires the business to have a proven financial track record before the insurance company will issue the policy. So a business in the early stages may find that CI is the only way to insure buy-sell agreements.

However Buy-Sell CI has a significant downfall in comparison to it's DI counterpart: it only pays out on the diagnosis of a specific set of illnesses and injuries. If the buy-sell agreement is broader in scope to cover off any disability for any reason (which would make sense), then there may be cases in which the buy-sell agreement kicks into effect, but the insurance policy doesn't pay out the money to grease the transaction.

In both cases, there are a number of snares and pitfalls that can be avoided with proper legal, tax, and financial planning. It is imperative that consultations with your team of financial professionals (lawyer, accountant, financial planner) should be arranged to make sure the agreements and corresponding policies are drafted to suit everybody's best interest.

This article is from Nora Dunn of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Business Succession Planning Part 2: How Life Insurance will insure the Life of Your Business

Nora Dunn — Sat, 09 Feb 2008 02:13:37 +0000

As a follow up to my first article on Business Succession Planning, there are a number of ways that Life Insurance can be fit into the life of a successful business owner.

There are two basic ways in which a business owner will want to look at Life Insurance for the life of their business:

Buy-Sell Agreement Funding

As referenced in my previous article, if an owner dies in a situation where there are multiple partners (or even as few as two) who own the company, the shareholder's agreement likely has provisions for the deceased owner's shares to be bought by the other owners.

Here's the rub: depending on how the shares are valued and depending on how large the company is, the other owners probably don't have the cash kicking around to buy out the deceased's shares at the drop of a hat. Nor does the company have that kind of dough in the bank.

In fact, many a company has gone bankrupt or into unshakable financial duress due to improperly funded buy-sell agreements and the consequent inability to carry the terms through.

Structuring Life Insurance for Buy-Sell Agreement Funding

The way around this mess is to purchase Life Insurance on the lives of each of the owners. The beneficiaries are the surviving company owners. That way if Bob dies, a life insurance policy on his life will give the other owners the cash to purchase Bob's share of the company. The company remains solvent, and Bob's estate (family) receives the money from Bob's share of the business.

The good news is that depending on how the policy is structured and the type of business, the life insurance premiums are often tax-deductible, and the insurance proceeds are also tax-free. It's a great way to process a relatively small tax-deductible expense with the promise of receiving a relatively large tax-free lump sum of money just when it is needed.

Key Man Insurance (Key Person Insurance)

Business owners are quick to insure the company against the loss or damage of its property on the basis that office equipment and inventory are valuable assets. Such assets, however, may not be as valuable as key employees.

Consider a top salesperson who is unsurpassed at bringing in new accounts, or a manager who handles the day to day operation of the business. Key employees like these are a firm’s most valuable resource.

If a key-person died suddenly, profits could be impacted and there might be considerable costs incurred in recruiting, hiring and training a suitable replacement.

So why insure the life of a key employee? Although it won't replace the work that the key employee did, the extra cash will provide a cushion to:

Keep the business running
Offset expected reductions in sales revenue
Find and train a new person to assume the deceased’s role

Believe it or not, when applying for substantial business loans, some banks will actually look for key man insurance depending on the structure of the firm to ensure that an unexpected death won't be the end of the company (and an end of the loan payments).

Examples of key employees would be anybody whose special skills contribute significantly to the bottom line, like:

Active business owners
Employees who have strong relationships with major customers
Employees with specialized knowledge that is hard to replace

Structuring a Key Man Policy

The company purchases a life insurance policy on the employee. Both the owner and the beneficiary of the policy is the company. So if the employee dies, the money goes to the company (tax-free).

Obviously the amount of insurance needed is dependent on the level of value the employee has on the company's operations. Things to consider include:

How much would it cost to replace the employee? (including recruitment fees, etc)
How much net profit does the employee's work result in?
How much would it cost the company if the employee died today?
How much can the business afford (or how much is the business willing to afford) for this insurance?

The need and desire for Life Insurance (either Key Man or Buy-Sell funding) will vary from company to company and person to person. It is an intricate situation that incorporates the nature of the business, the needs of the owner(s), as well as their respective family situations. No one piece of the pie can be examined in isolation from the others.

And with so many things, life will continue to change, so periodic re-evaluation of needs (along with a "gut check") is always prudent.

This article is from Nora Dunn of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread:

Business Succession Planning Part 1: What a Shareholder's Agreement Means to You

Nora Dunn — Mon, 04 Feb 2008 01:46:18 +0000

There are way too many business owners out there who assume that their business will provide for them in retirement, without actually considering how the business should succeed them.

And more business owners yet who are part of partnerships with other owners who all start as friends or family members with the best of intentions, but don't stop to consider and prepare for the inevitable - be it the death or disability of an owner, a marriage breakdown, or a falling out between co-owners.

Without properly giving these scenarios due consideration and preparing for them diligently, disaster can prevail.

A Shareholder's Agreement is one such way to cover off the bases and provide a road map for the tricky world of life's twists and turns.

A Shareholder's Agreement is also known as a Buy-Sell Agreement, or Business Will. Although there is reference to shares in both the title and many of the clauses, similar agreements are drafted for non-corporate partnerships and will cover many of the same issues.

What's Covered in a Shareholder's Agreement

A Shareholder's Agreement will dictate exactly what happens when:

A partner wants to sell their share
A partner becomes disabled
A partner dies

…among other life circumstances that may affect the business, which we will discuss below.

Advantages of a Shareholder's Agreement

Preserves value of the business
Satisfies the needs of surviving owners
Minimizes tax implications
Maintains harmony between surviving family members and business partners (in the event of a death or disability)

Clauses to Include

Following are a number of clauses that business owners may want to consider putting into their Shareholder's Agreement:

1) Restrictions

This clause will dictate the restrictions on each owner's ability to sell, give, or bequeath their share of the business to anybody outside of the group of owners without prior permission or approval.
Obviously this is important, in order to maintain the synergy and efficiency flow of the business's operations.

2) Valuation

How will the company be valued in the event of a sale (either of the business entirely or of an owner's share thereof)? Will you have a professional valuation? Or use the adjusted book value, or capitalized earnings, or a combination?

3) Funding Clause

This details how the owners can buy the shares of a disabled or deceased owner through the use of specific insurance policies. (These will be addressed below and in future articles in this series).

4) Payment Clause

This specifies exactly how payment can be made when buying another owner's share. Options include a lump sum, instalments, as well as the interest charges on unpaid balances.

5) First Right of Refusal

First Right of Refusal allows a co-owner who wants to sell their share of the business to do so, but they must first offer their share to the other co-owners. If they refuse to buy, the selling co-owner has the right to sell to a third party at the same price they offered to the co-owners or higher (but not lower).

6) Shot-Gun Clause

"You buy me out right now, or else I'm going to buy you out"!

With this clause, an owner would approach the other owners and offer to sell their share of the business for "x" dollars. If the other owner(s) refuse to buy, then their share of the business will be bought for that price. It is often used in the event of a falling out of the owners, as it culminates in one of the partners being bought out.

This gets sticky if one of the owners is in financial trouble and the other owner knows about it and exploits it. They can offer to sell their share under the shot-gun clause, knowing that the owner in financial trouble doesn't have the ability to pay up. Then, the sneaky one has the right to buy out the other owner. And unless this clause is worded correctly, the price could be well under the fair market value, but the owner in financial duress would have no choice but to sell at that price if they can't buy out the other owner at the same price.

7) Disability

If one of the owners becomes permanently disabled (or disabled long term without an end in sight), such that they can't perform their tasks as part-owner, it is often best that their share is bought out. Issues to address in this section of the agreement include:

How the buyout is funded (since the individual owners or company books probably don't have the cash hanging around to do this - there are insurance policies for this sort of transaction)
Terms of the disability which will trigger the buyout. For example, how long must the disability continue before the buyout process begins, and exactly what are the criteria the disability (and its effect on the business).

8) Death

Similar to disability, how is the deceased owner's share dealt with? Usually life insurance on the life of each business owner is used to fund the buyout, but even then there are different ways to structure the policy.

It can also be written into the buy-sell agreement that the deceased's shares are to be bequeathed to a spouse or child until their own death, at which time the shares are sold to the remaining owners or redeemed back to the company itself.

9) Retirement

So many business owners assume that their business will somehow take care of them in their retirement years, not knowing exactly how. Salaries and bonuses are often the main form of income (rather than share dividends), so when the salary stops as the active work does, what will provide for retirement income? Will there be money in the company to buy out the retiree's share? Proper structure and funding around retirement is an essential part of the buy-sell agreement and business succession plan.

10) Marriage Breakdown

If one of the owners gets divorced, that owner's shares may be subject to a division of property along with everything else that gets split. This can obviously wreak havoc with a business, if a divorced spouse suddenly becomes part owner of a business they had no previous involvement in when the marriage was on solid ground.

As with any legal agreement, thorough discussion is a pre-requisite to a trip to the lawyer's office. The topics covered off above are rarely ones that just "come up" over drinks after work, so a special and concerted effort must be made to ensure the business will continue to run smoothly and successfully in the event that life throws us those inevitable curve balls.

This article is from Nora Dunn of Wise Bread, an award-winning personal finance and credit card comparison website. Read more great articles from Wise Bread: