A buy-sell agreement, also known as a buyout, is designed to protect or continue a business should it experience an unforeseen circumstance. If a co-owner wants out of the business, to retire, to sell their shares to someone else, goes through a divorce or passes away, a buy-sell agreement acts as a sort of “premarital agreement” to protect everyone’s interests, setting the price and terms for a buyout. These are binding contracts between co-owners that control when owners can sell their interest, who can buy an owner’s interest and what price will be paid.
Buy-sell agreements can be used to lower estate taxes in businesses where at least one co-owner plans to leave the interest to heirs who will remain active in the business. This can help a family business owner pass the business onto children or other relatives without burdening them with unnecessary estate taxes caused by an aggressive value of the business. The key for estate planning is choosing a conservative price or valuation formula for the business in the buy-sell or buyout agreement. The result can be to legally set the value of the ownership interest at an amount considerably lower than its sales value at the time of death.
Most buy-sells are funded with life insurance because it is the only means of guaranteeing that death, the event which creates the need for cash, also, creates the cash to satisfy that need. Other alternatives are available such as borrowing or creating an installment plan, but life insurance is the most common.