What Is a Buy-Sell Agreement?
A buy-sell agreement stipulates how a partner's share of a company will be reassigned if he or she either dies or walks away from the business. These agreements detail a reasonable sale price for the current owner’s interest as well as when and how each party's share will be distributed to those who'll assume control.
A buy-sell agreement lets you and your partners or investors know who owns what percentage of the business instead of leaving the decision to the courts.
Setting a fair value for each share in a company can prevent potential legal conflicts by proactively establishing an exit plan, should the business partners decide to go their separate ways in the future. Buy-sell agreements establish an understanding of what should happen in that situation ahead of time, making it a great way to prepare for potential departures in the future.
Buy-sell agreements are similar to wills in that they determine which parties are entitled to a share. Without it, the deceased partner's next of kin may want to take over a portion of the business without input from fellow owners.
Let's take a look at the key aspects of a buy-sell agreement.
- Ownership percentages establish a fair value for each partner's share in the business. This comes in handy if a partner wants to remain part of a company after another partner exits. The limitation of ownership transfer rights are explained for right of refusal.
- The exiting owner gives notice to the business of their intent to sell. The agreement will clearly state the price paid for each owner's stake. This can be helpful if the owners have a dispute later on about the value of the company or about a specific partner's interest. The partners can just use the valuation methods included in the buy-sell agreement.
- The two most common buy-sell agreements are as follows:
- Cross-purchase agreements allow remaining owners to purchase the interests that belong to either a deceased owner or an owner who is selling his or her interest.
- Redemption agreements require that the business buys the interests of the owners who are selling their interests.
- A hybrid model is a situation in which a certain percentage is available for purchase by the individual partners and the remaining interest is purchased directly by the partnership.
- The agreement notes how it can be changed or terminated in the future. Add the choice of a law provision if a legal dispute arises. This will clarify which laws in which state will pertain to the agreement.
With buy-sell agreements, your business-related future will no longer be in limbo. In turn, it is far less likely that an exiting partner or a deceased partner's heirs will initiate an argument over the value of their shares. The last thing you want to do is leave your partners in a vulnerable state of circumstances in which your company is disrupted, dissolution is on the rise, or heirs decide to sell.
Look at a buy-sell agreement as though it's simply another step in the business planning process. Implementing a buy-sell agreement can prevent your company from having to face financial or legal difficulties down the road. View it as a transition pertaining to ownership, as it allows you to identify the relevant parties, their stakes in the ownership of the company, and how everything should be handled in the event that undesirable events unfold in the future.