While building their businesses, entrepreneurs are usually not thinking about their end game.
"You're at the beginning of your company. You're presumably in a good place with your business partner. Planning for its end is not something you want to focus on," says Shabnam Weber, owner of Toronto-based Academy of Tea, which offers educational courses about tea and a tea-sommelier certification program.
But owners of small and medium-sized businesses must plan for not-so-happy endings, and experts say having a buy-sell agreement in place can ensure an ownership transition goes as smoothly as possible. They are especially necessary for business people with personal wealth on the line.
The agreement is a contract that documents the planned transfer of ownership for a business, and entrepreneurs who have gone through such transitions, including Ms. Weber, know how valuable they are.
"Think of it as an insurance policy," Ms. Weber says. "The benefit of an insurance policy is that you are protected when something happens. The risk of not having one is a potential disaster."
Conflict and distraction can result if no agreement is in place, says Adam Shapiro, a family business advisor and partner with Guilfoyle Financial in Toronto.
"A lot of things can go wrong," Mr. Shapiro says. "The real benefit of these agreements is to have as seamless a transition as possible and the business continues to be as successful as possible."
The agreement comes into effect when events occur that are set out in the document. They typically include death, disability, divorce and retirement.
Once the triggering event occurs, the buy-sell agreement lays out the terms of the transfer of ownership, such as who is eligible to be an owner, what the purchase price will be and what will be the method of payment.
Having a buy-sell agreement becomes even more critical as the value of the business, and the wealth of the owners, increases. "Because the value of each shareholder's interest is greater, this will usually result in an increased likelihood of a dispute arising if a well-drafted, unambiguous buy-sell agreement is not in place," says Brad Sollis, a Vancouver-based partner with Norton Rose Fulbright Canada LLP and a buy-sell agreement expert.
Wealthy business owners typically have the resources to pay for experienced tax and legal advice, he says.
Mr. Shapiro says a buy-sell agreement is a good idea for any privately owned business, although a micro-business with one owner who is also the sole employee probably doesn't need one because there likely will be no ownership transition. But these agreements are crucial for businesses with more than one owner or shareholder.
Disagreements can crop up when ownership must change and emotions run high. A well-drafted document that sets out precisely what will happen is worth its weight in gold, says Mr. Sollis.
"If the owner is terminated or dies or goes through a divorce where their shares are subject to claim by the spouse, to have that certainty can be invaluable," Mr. Sollis says. It provides a clear path forward, which reduces stress and offers the owners some liquidity, he says. With the buy-sell agreement in place, describing who can own the business and how much it's worth, the risk of having to sell the departing owner's interest – or even the entire business – is greatly reduced.
But without that path, the ill will created as opposing sides argue can be extremely damaging to a business.
"Any dispute at the shareholder level, if it becomes known to employees, customers, suppliers, landlords or others, it can create concern in their minds about the ongoing viability of the business," Mr. Sollis says.
Almost as damaging as having no agreement in place is having a poorly drafted one. Mr. Sollis says it's important to consult an experienced lawyer, and to seek tax advice.
"The operation of a buy-sell clause will have tax effects on the parties, and it's important to know what those are and structure the buy-sell clause in a manner that is tax-advantageous to the parties of the agreement," he says.
Business owners should also consult with an insurance broker. It's common for buy-sell agreements to be funded through coverage on the life of the owners, so there is enough cash on hand to buy out the owner's interest in the event he or she dies. An insurance broker can advise on the best policy and ensure the policy amount will be enough.
Both Mr. Shapiro and Mr. Sollis agree it's a good idea to revisit a buy-sell document regularly because businesses evolve, and their value changes.
"The reality is a lot of buy-sell agreements are drafted and put in the filing cabinet and forgotten about until one of these events arises, and then they become the most important document in your world," Mr. Sollis says. "It is best practice to revisit them on an annual basis to make sure the terms are still appropriate."
Considering how important a buy-sell agreement can be, it's best to have one in place at the outset of the business, experts say. Even if that hasn't happened, it can be done after the fact, Ms. Weber says.
"It's never too late to have one," she says. "It will be a difficult discussion, but if you need it at some point, you'll be immensely grateful you did it."