THE FUNDAMENTALS OF A BUY-SELL AGREEMENT

A buy-sell agreement is essential to your company’s long-term security, and it’s important to understand the basics of how these types of agreements function. A buy-sell agreement is a legal document that specifies what happens to a business in the event of unexpected occurrences, such as the death or departure of an owner or partner. Let’s say for instance the co-owner of a business doesn’t want to be involved with a company anymore or is ready to retire. If the company has a validly executed buy-sell agreement in place, the price and and other terms of a buyout will be outlined by a binding contract. Such terms should include when a co-owner can sell their company shares, who is allowed to buy the shares, and how much the buyer will pay. If the company doesn’t have a buy-sell agreement, all of these variables are potential areas of dispute, which can lead to expensive and time-consuming legal battles.

 

Why a Buy-Sell Agreement is Important for Your Business

Multi-owner companies that have a buy-sell agreement have a contract stating what will happen to the business in case of death, conflict, disability, or other unforeseen events. A buy-sell agreement acts as an insurance policy of sorts, protecting your business against the unknown.

One of the ways a buy-sell agreement can benefit your business is by creating a detailed plan of what will happen to the business in case a partner dies or chooses to sell his shares in the company. This agreement can specify the use of life insurance policies as a way to fund the transfer of shares and prevent your business from depleting valuable cash reserves as a result of an unforeseen event. Some buy-sell agreements require the company to purchase life insurance policies on each of the partners, where the company would pay the insurance premiums, and receive the death benefit to purchase the deceased partner’s share of the company. Similarly, a buy-sell agreement can also specify that each partner pay for a life insurance policy on every other partner. In this case, each partner would be responsible for paying the insurance premiums and would receive the death benefit to buy the deceased partner’s share of the company.

A buy-sell agreement details what will happen should a partner leave the business, whether or not it is of his or her own accord. Thus, it decreases the likelihood of disagreement between partners and the emergence of potential legal battles as a result of such disagreement.

 

Drafting Buy-Sell Provisions in an Operating Agreement

When drafting a buy-sell agreement, there are a variety of factors you should consider. Here are a few examples of components that you should reflect on when creating a buy-sell agreement for your business.

 

  • Business Objectives

Some of the most crucial questions to ask yourself when structuring a buy-sell agreement should focus on the basic objectives of your business. What are your short-term goals? How about long-term? What is the exit strategy of the owners? Will the business be sold, or passed on to the owners’ heirs? Co-owners should be on the same page in regards to the direction the company is moving.

 

  • Determining the Type of Buy-Sell Agreement

An important aspect of structuring your agreement is deciding the type of buy-sell agreement that is best for your business. There are various types of agreements that all have different stipulations. Some require the current owners to buy out the other’s shares in the case of death or another triggering event while others allow the company itself to buy the shares. It’s a wise idea to explore your options when it comes to deciding the structure of your buy-sell agreement.

 

  • Deciding the Purchase Price

When transferring shares from one partner to a potential buyer, it is common for the third-party buyer to offer fair-market price for the shares. However, if there is no potential buyer, and either the company or the other partners are purchasing the shares, then the all of the partners should agree upon a method of valuation that accurately reflects the value of the shares being transferred. Some factors to consider when determining the value of company shares, and the terms of a transfer are; What are the events that caused the termination of one partner’s involvement in the company? Is the company’s business significantly affected by the departing partner? Is there a bona-fide third party offer for the shares? Will installment payments be allowed when purchasing the shares? Considering such factors and including them when drafting a buy-sell agreement will make the process of transferring shares much easier.

If your business doesn’t already have a buy-sell agreement in place, it’s a good idea to create one that dictates what happens to your business in the event of unforeseen circumstances.

Contact us today to learn how we can draft a buy-sell agreement that best meets the needs of your business.