A buy-sell agreement, buy-out agreement or a business prenup, is typically a contract that specifies how a partner’s share of an enterprise will be reassigned if he or she happens to pass away or dispense themselves from the company. Buy-sell agreements are commonly used for closed corporations and partnerships but may be used for other types of companies as well. The agreement will likely articulate who may purchase their interest of the company and the price that it can be purchased for. Among other things, a buy-sell agreement may also contain a clause that describes the circumstances at which the partner’s interest may be disposed.
Why is a Buy-Sell Agreement Important?
From the beginning of any establishing business, a formal agreement put in place is beneficial in many aspects, especially when individuals go into business together and share an interest in the enterprise. Without a buy-sell agreement, business owners may be exposed to costly litigation down the road when a partner decides to leave the company. Essentially, the agreement puts in place a succession plan for your business.
What are the Key Elements of a Buy-Sell Agreement?
Every buy-sell agreement should include a provision that identifies the parties in the contract and their determined interest in the business. Additionally, a valuation clause should also be included to protect the business capital and provide an appropriate assessment. This specific provision is important because it will lay out an accepted value price when the co-owner’s interest is able to be purchased by another. It will also protect against litigation that can potentially stem from value that is in dispute by the partners. Most importantly, the events that will set-off the buy-sell agreement should always be included. Events that are quite common are death, divorce, retirement or the transition of business owner interest to another employee of the company.
What Kind of Buy-Sell Agreements are Commonly Used?
Many companies choose to have different variations of a buy-sell agreement; however the two most common agreements are as follows: the first is called a stock redemption agreement which essentially allows the owners to sell their shares back to the company, the second form of the agreement is known as a cross purchase agreement, where the company’s partners or shareholders purchase the share of the interest that is being forfeited. Lastly, the company may choose to combine both of those into one agreement, which will allow the flexibility for the business and its owners.
