Life continually changes and sometimes those transitions can destroy a family business if it hasn't properly prepared. The primary safety mechanism is a well-drafted buy-sell agreement.

Among the threats to a family business are retirement, divorce, death and co-owning relatives who simply want to get out of the business and receive an attractive offer for their holdings. Each of these can put the business into immediate and perhaps long-term survival risks.

Think of the buy-sell agreement as a sort of "premarital agreement" where everyone can agree in advance on what events trigger the accord and how these situations will be handled. There are two basic varieties of buy sell agreements:

  • Redemptive agreements that obligate the business itself to redeem shares, and
  • Cross-purchase agreements, under which remaining co-owners bear a proportionate obligation to buy the shares of any retired or deceased shareholder.

In either case, the buy-sell agreement has two main purposes:

  1. Preventing each shareholder, partner, or member of the corporation, or partnership from unilaterally transferring an ownership interest to anyone outside the existing group, and
  2. Ensuring there will be a willing buyer for each co-owner's interest when a triggering event occurs.

The triggering events are specified in your buy-sell document. Events that should always be included are death, disability, and attainment of a stated retirement age. Other triggering events could be, for example, bankruptcy, the loss of one's license to practice a profession, the divorce of a co-owner, or the desire to cash out by withdrawing from the business.

Under the agreement, when a specified triggering event occurs, that person's ownership interest must be sold to — or at least offered for sale to — the remaining co-owners or the business itself. Most buy-sell agreements grant the remaining co-owners or the business a right of first refusal. If that right is not exercised, withdrawing co-owners (or heirs) are typically free to sell the ownership interests to an outside party without permission from the remaining co-owners.

Next, the buy-sell agreement should stipulate a method for valuing the business ownership interests, along with terms regarding how amounts will be paid out to withdrawing co-owners or their heirs. You want to make sure any price-setting method is respected by the Canada Revenue Agency for estate tax valuation purposes.

Common valuation methods include a fixed per-share price, using an appraised fair market value figure, or following a formula that sets the selling price as a multiple of earnings or cash flow.

The end result is a guaranteed market for each withdrawing co-owner's interest coupled with the ability of the remaining co-owners to keep control over who can join the business. As you can see, this is a beneficial financial arrangement for all parties - whether you're the first original co-owner to withdraw or the last owner standing.

A Buy-Sell Agreement Can

  • Transform your closely held business ownership interest into a liquid asset.
  • Prevent unwanted changes in ownership.

Warning: Make sure buy-sell agreement provisions don't conflict with terms of your company's articles, bylaws, partnership agreement, or operating agreement.