A buy-sell agreement is a legally binding contract that outlines what happens if a business owner leaves the business or passes away. This important agreement helps protect both the departing partner and the remaining business owners. For companies with more than one owner, having a buy-sell agreement is considered a business necessity. While it may seem like more of a bother than a necessity, having a well-developed buy-sell agreement will prevent future arguments and painful partner departures.
A buy-sell agreement specifically spells out the process for transferring a departing owner’s share of the business. It states that the remaining owners must purchase the departing partner’s interest in the company. This is known as a “mandatory buyout provision”. The agreement details the valuation method and timeline for the remaining partners to buy out the shares.
There are two types of buy-sell agreements: cross-purchase agreements and entity-purchase agreements. Cross-purchase agreements allow the remaining owners to buy the interests of a deceased or selling owner. Entity-purchase agreements require the business entity to buy the interests of the selling owner. Often life insurance policies are written into the agreement. This life insurance provision provides a guaranteed source of funds to the remaining owners if a partner were to abruptly die.
Having a clear buy-sell agreement prevents future disputes, establishes expectations, and provides continuity for the business. It gives remaining owners control over who joins them rather than inheriting a partner’s heirs. The agreement may also include restrictions on selling shares to outside parties.
Buy-sell agreements have something called “triggering events”. Triggering events are events that happen that trigger the provisions within the buy-sell agreement. Some of the most common triggering events are listed below.
- Retirement
- Leaving voluntarily
- Disability
- Divorce
- Death of a partner
Many different valuation methods can be used in a buy-sell agreement. Some common methods include book value, fair market value, and capitalization of earnings. However, a buy-sell is not limited to these formulas. Any formula for determining Company value can be agreed to and accepted by the business owners. To avoid any potential disputes in the future, the buy-sell agreement will establish a date and identify a common valuation method or a predetermined formula to be used to calculate the reasonable market value of the shares changing hands. The goal of a buy-sell agreement is always to facilitate a smooth transition while being fair to all parties involved.
A properly structured buy-sell agreement can provide peace of mind to all business partners. It ensures a fair process will be followed if an owner or owners experience any number of triggering events. This thorough planning helps solidify the company’s future leadership and operations. Consulting a legal advisor when creating a buy-sell agreement is highly recommended to ensure it is comprehensive and enforceable. With the right preparation, buy-sell agreements allow jointly owned businesses to confidently plan for inevitable ownership transitions.
