Ensure Your Construction Company’s Existence with a Buy-Sell Agreement

Published:

clip_image002

Tim Ayler, CPA | Partner, Audit and Other Assurance Services and Team Leader of the Construction Services Group

The very existence of a business could be jeopardized by an ownership change. That is why a buy-sell agreement should play a key role in every contractor’s succession plan.

Have you considered how to handle the departure, expected or otherwise, of any of your construction company’s owners? If not, the very existence of your business could be jeopardized by an ownership change. That’s why a buy-sell agreement should play a key role in every contractor’s succession plan.

Carrying On

Essentially, a buy-sell agreement is a contractual agreement ensuring that a 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 occur. 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 the loss of a professional license or certification.

Should a triggering event occur, your buy-sell agreement needs to determine the method used to estimate the value to help avoid expensive disagreements with spouses or other beneficiaries.

Maintaining Control

Whatever the reason for a departure, the remaining partners will need to come up with a substantial amount of money to keep the business under their control. To do so, life insurance can often prove useful.

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.

Finding Other Options

Insurance does have its downsides. Premiums may not be equitable if the partners’ ages are significantly different, and some partners may not be insurable because of age or other conditions. A couple of other options to consider are:

1. Funding the agreement yourself. 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 chose 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.

2. Using 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.

Getting It Done

If you’ve yet to establish a buy-sell agreement, move this task up to the top of your to-do list as soon as possible. The personal conflicts and legal ramifications of an ownership dispute can truly devastate a construction company. And remember, the agreement should be a living document subject to regular review and updates.

Contact Information:

Tim Ayler, CPA | Partner, Audit and Other Assurance Services and Team Leader of the Construction Services Group | 317-260-4401| Tayler@greenwaltcpas.com.