A buy and sell agreement (or buy-sell agreement) is a legally binding contract that outlines how a partner’s share of a business may be reassigned if that partner dies or otherwise exits the business. Typically, the agreement mandates that the available share be sold to the remaining partners or to the partnership itself. These agreements often utilize life insurance policies to fund potential buyouts in the event of a partner’s death.
A buy and sell agreement may also be referred to as a buyout agreement, a business will, or a business prenup.
Key Takeaways
- Buy and sell agreements dictate how a partner’s share of a business may be transferred in the event of the partner’s death or departure.
- These agreements often establish a method for determining the value of a business.
- Common forms of buy and sell agreements include cross-purchase and entity-purchase (redemption) agreements; some may combine both types.
- Cross-purchase agreements allow remaining owners to buy the interests of a deceased or selling owner.
- Redemption agreements require the business entity to buy the selling owner’s interests.
How Buy and Sell Agreements Work
Buy and sell agreements are essential for sole proprietorships, partnerships, and closed corporations, aiding in the smooth transition of ownership when a partner dies, retires, or leaves the business. The agreement requires that the business share be sold to the company or remaining members based on a predetermined formula. In the event of a partner’s death, the deceased’s estate must agree to the sale.
To ensure funds are available for the purchase, life insurance policies are taken out reciprocally by each partner on the others’ lives, often funded by the company as a business expense. Upon a partner’s death, the life insurance death benefit will be paid to the surviving partners, who then use the funds to purchase the deceased’s shares, thus ensuring business continuity and a stable ownership structure. This prevents costly conflicts over control, avoids involvement of probate court, and ensures shares are kept within the business.
Types of Buy-Sell Agreements
There are two common forms of buy-sell agreements:
- Cross-Purchase Agreement: The remaining owners purchase the share of the business that is for sale.
- Entity-Purchase Agreement (Redemption Agreement): The business entity buys the deceased’s share of the business.
A combination of the two may be utilized, allowing portions to be bought by individual partners and the remainder by the partnership. A wait-and-see agreement merges elements from both, leaving it flexible until a decision is needed based on business continuity requirements.
In scenarios involving sole proprietors, a key employee may be designated as the buyer or successor. Writing up a buy and sell agreement should involve consultation with an attorney, certified public accountant, and a life insurance professional.
Key Considerations in Buy-Sell Agreements
Buy and sell agreements protect partners by managing potentially difficult situations while safeguarding personal and family interests. For instance, the agreement might restrict owners from selling their interests to external investors without others’ approval. This protection extends to instances of a partner’s death, preventing the estate from selling the interest to outsiders.
The agreement specifics typically include the stipulation that a deceased partner’s share be sold back to the business or remaining owners, controlling business ownership. It also outlines methods for assessing the business’s value, contributing to resolution of owners’ disputes regarding company valuation.
Buy-Sell Agreement Templates
There are several online resources offering low-cost or free templates for drafting a buy-sell agreement, beneficial for new or small businesses. However, as the business grows or if it involves numerous partners, employing a lawyer to draft the document is advisable.
Establishing a Buy and Sell Agreement
A buy-sell agreement is a contract that lays out how a partner’s shares will be reassigned in the case of death or departure, frequently established through an attorney. Life insurance policies are typically purchased on the partners to ensure funds are available for purchasing a deceased partner’s business interest. This aspect should be managed by an experienced life insurance agent familiar with such agreements.
Key Components of a Buy and Sell Agreement
A well-drafted buy and sell agreement should include the following details:
- List of triggering buyout events (e.g., death, disability, bankruptcy, retirement)
- List of partners or owners involved and their current equity stakes
- Recent valuation of the company’s overall equity
- Funding instrument, such as life insurance policies
- Tax and estate planning considerations for individual partners and beneficiaries
Benefits of a Buy and Sell Agreement
A buy and sell agreement ensures a smooth transition of ownership and business continuity when a partner exits or dies. This legally-binding contract outlines how leaving owners’ shares will be acquired by remaining partners, avoiding legal disputes and unclear ownership changes. Without such an agreement, shares may pass to a spouse or be sold externally, risking business instability or financial challenges for the remaining partners.
Conclusion
Ensuring business continuity is vital, especially when multiple partners or significant equity holders are involved. A buy and sell agreement is a crucial legal tool outlining a clear plan for redistributing shares of a departed or deceased partner to the others. These agreements, supported by life insurance for funding, maintain business stability and ownership continuity, protecting the business and its stakeholders.
Related Terms: cross-purchase agreement, entity-purchase agreement, life insurance policies, business partnerships, business will, business prenup
