CONSTRUCTION Accounting ARTICLE -
Buy-Sell Agreements: Sleep Better With This Key Document In Place
Target Audience: Construction Industry Professionals, Business Owners, Family Owned Businesses, Construction Accounting Consultants
When you and your business partners decided to start your own construction company, it may have never crossed your minds that one of you would want to leave. Or might get hurt. Or die suddenly. You were focused on building — both your business and your projects.
That’s understandable. But if you still haven’t considered how you might handle the departure — expected or otherwise — of a company owner, you could be putting the continuity of your business at risk. The good news is that a buy-sell agreement can help you sleep better at night.
Think What Could Happen
Essentially, a buy-sell agreement is a contractual agreement ensuring that your construction business will carry on if you or another owner leaves.
More specifically, it ensures that the departing partner has a buyer in place — whether it’s you, a family member or an outside party — when the time comes. Conversely, the agreement also can protect against your partner selling his or her share to an outside party against your wishes.
A buy-sell agreement typically gives you the right, or the responsibility, to buy a partner’s share of the company if any of a number of triggering events occurs. A triggering event may be the death of a partner, a disability, divorce, retirement or simply a desire to leave the company. You may have others, such as loss of a professional license or certification.
In any case, all triggering events that could affect your construction company should be specified in the agreement. And, should a triggering event happen, your buy-sell agreement should determine the method used to estimate the value to help avoid expensive disagreements with spouses or other beneficiaries.
Look Into Life Insurance
Whatever the reason for a departure, if a partner does leave, the remaining partners will need to come up with a significant amount of money to keep the business under their control.
Now, if you’re Bill Gates or Warren Buffett, you may have this covered. If not, you may want to consider taking out a life insurance policy on your partner — and vice versa, of course.
Assuming there are only two partners in the business, here’s how it might work: You would buy the insurance policy on your partner. Then, if he or she dies, triggering the buy-sell agreement, you’d collect the death benefit and use it to buy out his or her share of the business from the estate.
Doing so not only guarantees you’ll have the money needed to fulfill your obligations under the agreement, but also benefits you from a tax standpoint. Death benefits are tax free to the original purchasers of life insurance policies, so long as steps are taken to protect those benefits. (Consult your financial or tax advisor for further details.)
If more than two owners are involved, you might find it more efficient to establish a trust or separate partnership to buy a policy on each owner. If one of you dies, the trust or partnership collects the death benefits on behalf of each owner. You would get your portion from the trust or partnership and use it to pay your share under the buy-sell agreement.
You can also use disability insurance to get similar protection if one of the owners becomes unable to work. In either case, you won’t have to mortgage your holdings or raid your retirement funds to pay your share.
Consider Alternatives
Insurance is an effective hedge against death or disability, but it has some drawbacks. For one thing, premiums may not be equitable if the partners’ ages are significantly different. For another, some partners may not be insurable because of age or other conditions. And even if those aren’t considerations for you, how do you handle things if someone is divorcing or just wants out?
One option is to rely on the company to pay. This approach is somewhat risky, as it assumes your construction business’s income — and profits — will continue to grow as your construction business matures. The company accumulates earnings to fund the buy-sell under the expectation that it will have enough on hand when the time comes. If you choose this route, hedge your bets by including an installment payment option in the buy-sell agreement that will give you some time if you need it.
Another alternative is to fund the agreement with combination funding. Use insurance to guard against premature death or disability, and set aside corporate earnings to cover an owner’s departure for other reasons. Again, include an installment option to give yourself breathing room if you need it.
Give Yourself An Out
You may not want to believe that you or a partner will ever leave the construction company you’ve worked so hard to build, but that day might come. If it does, a buy-sell agreement will help ease the departure.
Factoring Family Matters Into Your Buy-Sell Agreement
If you’re the sole proprietor of your construction company, who will take it over when you’re ready to leave? A buy-sell agreement (see main article) can smooth the transition regardless of who takes over, but you should identify that person well in advance.
Don’t assume your children will be interested, or that one child will be more interested than another. The fact that your son has spent college breaks working for you doesn’t mean he’s more interested in taking over than your daughter who’s seen your office only twice.
Even if they’re interested, they may not be qualified or they may not agree with your vision for the company. In either case, you’ll need to decide whether you want them to take over when you’re ready to leave.
If not, you should identify a key employee or trusted colleague as your successor. Then set up the buy-sell agreement with that person in mind.
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