6 essential questions to answer when drafting your purchase-sale agreement

The opinions expressed by entrepreneurs contributors are their own.

So you did it. Your lifelong dream of being a homeowner is now a reality. You run a successful business. But have you thought about what happens when you're ready to retire? Or even worse, what happens in the event of an owner's premature death or disability? Although it may seem like a distant reality, planning for the legacy of the business you've worked hard to build is an essential ingredient to running a successful long-term business. And that's where one comes in.

A buy-sell agreement is, in its simplest definition, a contract between business owners to ensure succession. It is a fundamental tool that allows the business to continue to thrive as the organization and its owners grow and change.

Below are some of the key questions to consider when creating your buy-sell agreement.

Related: What is a buy-sell agreement and why is it essential for a successful partnership?

1. How will you fund owner departures?

Often we find that an owner's exit can cause the organization to produce a large amount of capital for owner buyout, which has the potential to create financial stress for the business. This can often be mitigated by stipulations in the purchase-sale agreement.

There are several ways to fund exits, including lump sum payments, installments, and phased stock transfers. Transferring this risk to a business can also alleviate the capital requirement of the business or other owners. Working with a wealth advisor and attorney can be helpful in finding a good financing option for your organization.

2. How should you structure the insurance policies held to fund a buy-sell agreement?

While it may seem unlikely, it is important to protect your business in the event of an owner's death or disability. The two most common forms of financed purchase-sale agreements are cross-purchase and entity purchase agreements.

Typically implemented in businesses with fewer owners, in a cross-purchase arrangement, each owner purchases an insurance policy from the other. This allows the surviving owner to fund a buyout using insurance proceeds and increases the survivor's tax base. It can also help reduce subsequent taxes due on a future sale of the business. In an entity purchase agreement, the company holds all the owners' insurance policies and uses the proceeds to buy out the shares, which are then retired.

Related: Estate Planning for an Owner Dependent Business

3. How do you replace owners who have exited?

Usually when the owners start leaving, the business is still in operation. Therefore, it is important that the purchase-sale agreement sets out the terms of transfer of ownership.

For example, who replaces this owner? What safeguards are in place for the person replacing this departing owner? How will knowledge transfer work? All of these should be outlined in your purchase-sale agreement to ensure that the business is not adversely affected by an owner leaving.

4. How do you prepare for the unthinkable?

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