Buy-sell agreements: planning for the unplanned

Family businesses make up around 70% of all Australian businesses. As we mark National Family Business Day, it’s a fitting time to reflect on the potential impacts of the death, incapacity or total and permanent disablement of a co-owner. These scenarios highlight the importance of having a structured business succession plan in place to manage the unexpected exit of a co-owner effectively.  

Buy-sell agreements offer an effective way for a surviving business owner to buy out an exiting business owner when specific trigger events occur. While often considered in a corporate context, these agreements can apply to any business structure, making them a useful business succession planning tool.  

What is a buy-sell agreement?

Buy-sell agreements are contracts between business owners, allowing for the sale of a co-owner’s interest should a trigger event, such as death, incapacity or total and permanent disablement, occur. They commonly incorporate ‘put’ and ‘call’ options under which, on the happening of a trigger event:

• the continuing owners can ‘call’ for the exiting owner to sell their business interest to the continuing owners; or
• the existing owner can ‘put’ their business interest to the continuing owners. 

A well-drafted agreement should incorporate mechanisms for valuing business interests, guidelines on how and to whom business interests can be transferred and funding options for their purchase. By turning their mind to the key issues that may arise if an unexpected trigger event occurs, business owners can minimise the disruption an unplanned exit brings and mitigate the financial loss associated with such upheaval.    

Buy-sell agreements are commonly used with insurance strategies, so the remaining owners can fund the acquisition of the affected co-owner’s business interest. There are multiple ways buy-sell insurance policies can be held, including:

• self-ownership: business owners hold a policy on themselves;
• cross-ownership: co-owners hold policies over the lives of the other co-owners; or
• business ownership: policies are owned by the business entity itself. 

Various taxation issues arise depending on the structure of the arrangements and the payment of insurance proceeds. It's important to ensure appropriate legal and tax advice is taken whenever entering a buy-sell agreement.

Without an appropriate business succession plan, a co-owner’s interest in a business will pass according to their personal succession plan on their death – often to a spouse or children. This isn’t ideal from a business succession planning perspective and can result in unnecessary dispute or discord among business owners, including decision making processes changing to include people not usually involved in the business, a forced sale needing to be contemplated or the affected co-owner or their estate not receiving the full value of their interest in the business.