Before you execute a buy-sell agreement, make sure that you have adequately funded it.

To adequately fund your buy-sell agreement, take each event that would trigger your buy-sell agreement (death, disability, retirement, etc.) and ask yourself “If this event happened tomorrow, would there be enough available funds to purchase the shares?”

The most common mistake I find is a buy-sell agreement that can be triggered upon disability, but the company or shareholder (depending on whether the buy-sell agreement is a stock redemption or cross-purchase plan) relies solely on life insurance to fund the agreement.

A permanent life insurance policy’s cash value takes time to build. And if a shareholder becomes disabled before the cash value builds up, such a company may be forced to fund the buy-sell agreement in non-optimal ways.

The problem of motivating and retaining key employees without giving away your company’s equity can be solved by the use of a phantom stock plan. Many company owners are hesitant to provide key employees with an actual company ownership interest. Such an ownership interest would likely entitle key employees to notice, inspection, and voting rights. Additionally, these key employees would be able to hold the company responsible for a breach of fiduciary duties. Thus, phantom stock is a great way to share the economic value of your company without the hassle of giving up company stock.

Phantom stock plans are contracts between the company and key employees designed to parallel actual ownership of company stock. Under a phantom stock plan, the company grants a certain amount of stock units to key employees. Each unit equals the value of a current share of the company’s common stock. In the typical phantom stock agreement, the benefit provided to the key employee equals the appreciation in the value of the stock between the date the employee was credited with the phantom stock and the date the benefit is paid. Other phantom stock plans can be based on company sales or profits.

You can implement a vesting schedule for phantom stock so that your key employees receive their phantom stock over time instead of all at once. Payment of the phantom stock benefit usually occurs upon termination of employment as a result of retirement, death, or disability. The benefit can be paid out in installments and in either cash or actual common stock of the company. Generally, benefits are paid in cash because the company does not want to give away ownership of the company.

When implemented along with other incentive plans, phantom stock can be a useful tool to retain key employees without the hassle of making them shareholders.

In a couple of previous posts, I discussed the value of buy-sell agreements for businesses with 2 or more owners and also one of the two major types of buy-sell agreements, the cross-purchase plan. This post is dedicated to the other main variation of the buy-sell agreement, the stock redemption plan.

Under a stock redemption plan, the corporation redeems the shares of the withdrawing stockholder. Retirement, death and disability tend to be the three most common withdrawal events found in buy-sell agreements, but corporations are not limited to those three and are free to mix and match as they see fit.

Read the full story

The cross-purchase is one of the two main ways (”stock redemption” the other) a buy-sell agreement can be structured to provide your company with a succession plan.

Under a cross-purchase plan, each company shareholder agrees in advance to buy the shares of the withdrawing shareholder while the withdrawing shareholder agrees to sell his or her shares to the remaining shareholders. The corporation is not involved in the transaction.

Read the full story

A buy-sell agreement is a document that preserves continuity of business ownership when specific events occur, such as death or disability of a business owner. It is a contract between shareholders or business partners concerning the future ownership of the business and can be drafted as part of the company’s shareholder agreement or as a separate agreement.

The buy-sell agreement typically controls events triggering shareholder buyout, persons that may purchase the departing shareholder’s stock, the valuation of the departing shareholder’s stock and how the buyout will be funded.

The advantages of a buy-sell agreement are that it sets out a strike price well in advance for the departing shareholder’s stock, creates a market for the business interest (which can be extremely difficult in closely held corporations) and assures business continuity for the remaining active owners, employees, customers and creditors.

Continuing with the theme of prevention, a wise entrepreneur drafts an employment contract for each and every employee he or she hires. But a wiser entrepreneur ensures the employment contract contains all the terms of the employment agreement, leaving little room (hopefully none) for later debate.

If you aren’t thorough drafting your employee’s contract, I’ll guarantee your employee will have selective memory about the terms of the deal. Often times small business owners just print out a contract template they find via Google or Barnes & Noble. When in reality, most employment situations are unique and require custom-tailored contracts.