What is a Buy-Sell Agreement? A buy-sell agreement is a legally binding contract stipulating when and how one party’s interest in a business will be transferred to another party. Buy-sell agreements are commonly used between existing business partners for succession planning purposes, but they can also be used by an existing business owner who is planning to sell their interest in the business when certain future conditions are met, i.e., when the owner is ready to retire and transfer the business to a key employee. A buy-sell agreement may be an independent document, but the terms can also be incorporated in the company’s operating agreement or close corporation agreement.
What Should Be in Your Buy-Sell Agreement? A buy-sell agreement should be used to answer the following questions:
Who can the business owners sell their interest in the business to? Often, buy-sell agreements require that any interest in the business be sold to (or at least first offered to) the remaining business partners rather than outsiders.
What events will trigger the buy-sell agreement? Common triggers include the death, disability, or retirement of an owner; the termination of the employment of an owner who is also a key service provider or employee; the divorce of one of the business partners; or even unresolvable differences between the owners. Remember, unless it is a family-owned business, you probably won’t inherit your business partner’s share of the business when they pass away. And if one of your business partners gets divorced, you certainly don’t want to deal with their former spouse should the divorce court award them some portion of the business interest when dividing the marital assets.
How will the value of the business interest be determined? A buy-sell agreement might use an agreed-upon formula to determine the value of the business interests, or it might call for the use of an outside appraiser to determine the value. If a formula is used to determine the valuation, it might take into account the book value of the business or use a multiple of earnings or revenue.
How will the buy-sell agreement be funded? In other words, where will the money come from to buy out the departing business owner?
Plan for Funding the Buy-Sell Agreement Buy-sell agreements only work as a succession planning tool if the parties make a plan for actually funding the agreement. For example, if your buy-sell agreement requires your remaining business partners to buy your share of the business from your estate upon your death, where will your business partners get the necessary funds if they don’t have the cash readily available? A common funding mechanism is to require either the business or the business partners to take out life insurance policies on all of the owners. When one owner passes away, the proceeds from the life insurance can be used to buy out their estate.
A good buy-sell agreement requires considering multiple “what-if” scenarios and planning for their impact on the business and the remaining business owners. Our business attorneys can help you plan for these many contingencies and craft a well-thought-out buy-sell agreement that works for all involved while protecting the business you’ve worked so hard to build.
The information contained on this website is not legal advice or legal opinion and should not be relied upon. Furthermore, nothing contained in this website is intended to create or establish, and does not constitute, an attorney-client relationship.