A buy-sell agreement is a legally-binding agreement between two co-owners that governs any situation in which one co-owner dies, choses to leave the business, is incapacitated, faces divorce, bankruptcy, retirement, or sells his/her share of the company. The agreement clearly defines next steps and financial responsibility in case such events occur.
A buy-sell agreement may also be referred to as a cross-purchase agreement.
Similar to a buy-sell agreement is the stock redemption agreement, which is an agreement between the business and its owners. Instead of the co-owner agreeing to buy out the ownership of the other owner(s), the business entity redeems the owner’s equity.
Buy-sell agreements, cross-purchase agreements and stock redemption agreements all accomplish the same goal which is to provide, in advance of its need, for a seamless business ownership transition when a business owner chooses to leave or otherwise is unable to continue their role as a business owner.
Who Should Have a Buy-Sell Agreement?
Those owners of all business entities including corporations, partnerships, LLCs and even sometimes proprietorships should have a buy-sell agreement. Each buy-sell agreement will be different depending on the business and number of owners and possible others who may have a financial stake in the business. Using a buy-sell agreement is extremely important for family businesses as well. Without a formal agreement in place before an untimely death or disability strikes, one family member may suddenly find themselves in a business partner relationship with their late or disabled family member’s spouse.
Even the most basic businesses and strategic partnerships can benefit from a buy-sell agreement. For example, if your partner dies, will his wife or next-of-kin become a co-owner of the business? Will you have the opportunity to buy their portion of the business ownership out of their estate? If so, under what terms and for what amount of money? The buy-sell agreement ensures that the business share is sold to the remaining owners based on a predetermined formula.
As more people with a financial interest become involved in a business, the buy-sell agreement becomes even more necessary.
Is A Buy-Sell Agreement Worth the Cost?
Unequivocally, yes. The cost and time of preparing a buy-sell agreement is minimal compared to its benefits. A well-thought-out buy-sell agreement, which is properly funded, will keep fighting co-owners and family members at bay, and help the business continue reliable operations and keep employees and vendor relationships intact in the midst of a major life event for one of its owners. And the value of the business will not be at risk of decline due to a potential shareholder dispute among family members.
Funding a Buy-Sell Agreement with Insurance
To ensure a business or one of its owners can buy-out another owner’s share, most owners purchase life insurance policies on each of the other owners. In the event of a death, the proceeds from the life insurance policy will be used to purchase all or a portion of the deceased owner’s share of the business. This ensures that the spouse or next of kin is bought-out as agreed upon, without a major disruption to business operations.
Creating the Buy-Sell Agreement Should be an Important Priority
Make sure to complete your buy-sell agreement early in the business partnership, while the relationship is good. While you may be life-long business partners, you never know when things might change for either in the future. Negotiating a buy-sell agreement is fairly simple when it’s reciprocal – that is, no one knows for sure who will be first to retire, be disabled, etc. At this time, it is in all parties’ best interests to complete a fair buy-sell agreement.
Get Professional Help
Enlist the services of a lawyer who specializes in drafting these types of agreements to guide you through the buy-sell agreement process. A lawyer will make sure you are creating the right type of buy-sell agreement, and walk you through the drafting process.
Holly also founded ExitPromise.com and to date has answered more than 2,000 questions asked by business owners about starting, growing and selling a business.
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