A Buy-Sell Agreement is a legally binding agreement between co-owners of a business that governs how a co-owner’s ownership interest is handled if that co-owner dies, is forced to leave the business, or chooses to leave the business. The situations where a Buy-Sell Agreement would be triggered include a co-owner attempting to sell his ownership interest to a third party, divorcing a spouse, declaring for bankruptcy, passing away, becoming disabled (or otherwise permanently incapacitated), or leaving the company (voluntarily, such as retirement, or involuntarily, such as “for cause” termination).
There are three types of Buy-Sell Agreements – a cross purchase, redemption, and wait-and-see agreement. In a cross-purchase agreement, if a triggering event applies to a co-owner, the other co-owners have the right to buy their share. With a redemption agreement, the business itself would make the purchase instead of the co-owners individually. In a wait-and-see agreement, the parties are given options. Typically, the business has the first opportunity to purchase the co-owner’s interest. If the business does not exercise this option within a designated period, the other co-owners have the option of purchasing the co-owner’s interest.
Life insurance is integrated into in many Buy-Sell Agreements but is not required. A life insurance policy ensures cash is available to facilitate the purchase of a co-owner’s share upon a triggering event. For example, if a co-owner dies, a life insurance policy on that owner’s life can be paid to the business so the business has enough liquid funds to buy out the deceased co-owner’s ownership interest (and consequently the co-owner’s spouse/heirs).
One of the most important terms of a Buy-Sell Agreement is the purchase price. The co-owners can agree to a fixed price (i.e. $5 per share) or a method to value the company. If the owners agree to use a valuation method, the method must be clearly indicated in the agreement. Some options include fair market value, fair market value discounted for lack of marketability, a method based on historical earnings or future earnings, or book value. Various methods are more beneficial for certain businesses and industries. Buy-Sell Agreements also can have a mechanism for the parties to agree on or select their own valuation experts to determine the value of the business based on the valuation method. Most disputes regarding the purchase and sale of business interests involve the valuation, so this term should be carefully agreed upon.
A Buy-Sell Agreement makes sense for any business entity, including corporations, partnerships, and LLCs, and is necessary to avoid disputes among co-owners departing a business. For example, you may not want to do business with the children or spouse of your business partner, and a Buy-Sell Agreement will prevent this.
Disclaimer: This material was prepared for general informational purposes only, and is not intended to create an attorney-client relationship and does not constitute legal advice. This material should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction.
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