Buy-sell agreements are an essential part of business, yet often misunderstood and misused.
A buy-sell agreement is a contract between two or more parties that says how a business can be sold or change ownership. This agreement is also known as a buyout agreement.
It is designed to protect all involved parties in the event of certain events (death, disability, bankruptcy, etc.).
Suppose you’re thinking about drafting your own buy-sell agreement.
This article will give you everything you need to know about understanding and drafting one.
We’ll go through what goes into a buy-sell deal, what to look out for, and how to ensure your interests are protected throughout.
What Is A Buy-Sell Agreement?
A “buy-sell agreement” between business owners sets out what happens to the firm if one of the owners passes away, becomes disabled, or decides to retire.
The agreement can buy out the owner’s interest in the company or sell the business outright.
The agreement should spell out how the business will be valued, how payments will be made, and who has the right to buy or sell the business.
It should also include what happens if an owner is still looking for a buyer for their interest in the business.
Creating a buy-sell agreement is essential in protecting your business.
It ensures its continuity in the event of an unexpected death or departure of one of the owners.
What To Include In A Buy-sell Agreement
The key terms of a buy-sell agreement should include the following:
The Trigger Event
What event will activate the sale of the departing owner’s interest?
This is typically death or disability, but it can also be an involuntary termination (such as being fired) or voluntary resignation.
The Purchase Price
How much will the remaining owners pay for the departing owner’s interest? This should be fair market value, as determined by an independent appraiser.
The Funding Source
How will the remaining owners finance the purchase of the departing owner’s interest? This could be through life insurance policies, bank loans, or personal savings.
The Transfer Restrictions
What restrictions will be placed on the departing owner’s ability to transfer their interest before triggering the sale?
For example, they may only be able to sell their interest to a third party after first offering it to the remaining owners.
The Governance Provisions
How will business decisions be made going forward? This is particularly important if there are unequal ownership stakes.
Types Of Buy-Sell Agreements
There are three common types of buy-sell agreements:
1. Cross-purchase Agreement
In a cross-purchase agreement, each co-owner purchases life insurance policies from the other owners.
When a business owner dies, the other owners use the money from the policy to buy out the dead person’s share of the business.
2. Stock Redemption Agreement
The business purchases life insurance policies for each owner in a stock redemption agreement.
When a business owner dies, the business uses the money from the policy to buy out that person’s share of the business.
3. Wait-and-see Agreement
A wait-and-see agreement is similar to a cross-purchase agreement, except that instead of each co-owner life insurance policies for the other owners, only one or two owners purchase policies for all of the other owners.
Usually, the decision about which owner(s) will buy the policy(ies) is made when a buyout is triggered, such as when an owner retires.
How To Draft A Buy-Sell Agreement
When drafting a buy-sell agreement, there are a few key things to keep in mind.
First, you’ll need to figure out who is part of the agreement and what their roles are.
Next, you’ll need to determine what assets are being exchanged and how they will be valued.
Lastly, you’ll need to spell out the agreement’s terms, including any conditions or triggers that would make a buy-sell happen.
Once you’ve got a handle on the basics, you can start drafting your buy-sell agreement.
When doing so, be sure to include provisions for dispute resolution, termination, and any other relevant clauses.
And be sure to have the agreement reviewed by an attorney before finalizing anything; this will ensure that it’s legally binding and enforceable.
Pros And Cons Of A Buy-Sell Agreement
The agreement protects the other owner(s) by giving them the first chance to buy the shares of the owner who is leaving.
This occurs if one of the owners dies, becomes disabled, or wants to sell their share of the company.
The agreement protects the remaining owner (or owners) by giving them the first right to purchase the departing owner’s shares.
It covers the business by providing continuity of ownership and preventing the uncontrolled sales of the company to outside parties.
While a buy-sell agreement can be a precious tool for protecting your business, there are also some potential drawbacks to consider before entering such an agreement.
One downside of a buy-sell agreement is that it can lock you into owning your shares even if you no longer want to be involved in the business.
For example, if you become disabled and cannot work, you may be forced to sell your shares back to the company at a price below market value.
Another potential drawback is that a buy-sell agreement can make it challenging to sell your shares on the open market if you want to cash out.
This can limit your ability to take advantage of opportunities that may arise down the road.
Overall, this can be a helpful tool for protecting your business interests. Still, it’s essential to understand both the pros and cons before entering such an agreement.
With the knowledge you gained here, you should be able to construct your own buy-sell agreement.
Various aspects of drafting a contract that may be agreed upon by both parties have been discussed.
These include trigger events, payment alternatives, taxes, and others.
You may safeguard yourself from legal issues in future company transactions and make sure that all terms are understood and mutually beneficial by establishing a detailed and precise buy-sell agreement.