Buy-Sell Agreements

What is a Buy-Sell Agreement?

Buy and sell agreements are formalized contracts directly outlining how a partner’s share of a business may be re-designated if that partner were to pass away.  Usually, the shares would be offered to the remaining partners or partnership prior to arranging an outside buyout.

Buy-sell agreements are also referred to as buyout agreements, a business prenup, or a business will.

How does a Buy-Sell Agreement work?

Often buy-sell agreements are utilized by sole proprietorships, partnerships, and closed corporations, so that when partners die, retire, or choose to exit the business, there is already a  formal process established for that transition.

The agreement instructs the business shares to be sold back to either the company or the remaining partners of the business based on a pre-negotiated formula.  If a partner dies, the estate agrees to sell back the shares.

Types of Buy-Sell Agreements

The two most popular types of agreements are:

  • A cross-purchase agreement, which means the surviving owners are able to purchase the remaining shares
  • A redemption agreement, which means the business itself can purchase the remaining shares of the business

It is possible to create a mixture of these two types of agreements with portions available for purchase by individual partners and the remainder bought by the business partnership.

When it comes to sole proprietorships, a key employee is able to be identified as the successor.

The Nuances of the Buy-Sell Agreement

Buy and sell agreements function to mitigate chaos once a business partner dies.  These contracts can help protect the business fully in the case of an unexpected (or expected) death.

There is an additional step that is often overlooked, which is arguably the most important focal point of the agreement.  It must be funded.  The funds are typically derived from life insurance bought by the partnerships on each partner, so that in the event of a death, the death benefit of the policy will purchase the shares.

It is paramount that businesses work with an attorney and accountant alongside their financial advisor, so that these agreements are both properly drafted and funded.

Why are Buy-Sell Agreements necessary?

These kinds of agreements are created, so partners can avoid potentially problematic encounters, while also protecting the business, personal, and family interests.

Ultimately, a buy-sell agreement can limit the opportunity to sell to outside investors without prior approval from all partners.  These agreements can function in the event of a partner’s death as well as if a partner decides they no longer want to own the business.

One such example is requiring a deceased partner’s interests be sold back to the remaining owners of the business, precluding an estate from selling shares to a stranger.  These agreements can also define the process by which the value of the partner’s shares are derived.  This process can be useful outside of buying and selling shares.  For instance, any disagreement surrounding company value, or a specific partner’s interest, can be resolved by utilizing the estimate strategy defined in the buy-sell agreement.

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