What Is a Buy-Sell Agreement?
A buy-sell agreement is a legal document that allows for the re-allocation of business shares or partial ownership of a business in the event of an owner or partner’s death, disability, retirement, or other major life event. With a buy-sell agreement in place, new owners or existing business partners can purchase a stake in the company. As such, it obviously has enormous benefits for exit planning and should be created in the early stages of a planned transition if the company does not already have one.
This legal document details exactly how a business will divide up assets and ownership should something happen to the business, one of its owners, or should an owner want to exit. This is enormously helpful in many ways.
First, a buy-sell agreement takes all of the guesswork out of a transition. By ensuring there are no surprises should something unexpected happen, all the parties involved can relax. There is no point in manipulating or attempting negotiations when everything has already been negotiated and included in the agreement.
What Types of Buy-Sell Agreements Exist?
There are several types of buy-sell agreements that can be tailored to a company’s specific needs. They are:
The cross-purchase agreement: This type of agreement is designed to provide for the remaining owners upon the death of one owner. It allows them to individually agree to redeem the business interest of the deceased owner. Typically it involves owners choosing to purchase life or disability insurance policies on the other partners in sufficient amounts to provide them sufficient funds to pay for the business interest.
The redemption agreement: With this type of agreement the business itself will typically redeem the business interest of the departing owner. The business then is responsible for purchasing that interest using its own resources, financing defined by the agreement, the remaining owners’ own money, or disability insurance on the life of the owner who is leaving.
Both cross-purchase and redemption agreements can involve the use of life or disability insurance funds to purchase business interests.
The hybrid agreement: This type of agreement combines aspects of both of the above types. Typically the hybrid agreement allows the business first right of refusal to buy the business interest of the departing owner. If the company passes, the remaining owners then have the option to buy. This type of agreement is constructed so that tax pitfalls can be avoided.
All kinds of organizations, including C and S corporations, limited liability companies, joint ventures, limited partnerships, and general partnerships can utilize buy-sell agreements to minimize stress, confusion, and risk during trigger events that force ownership changes.
Prometis Partners recommends that all companies with more than one owner or companies that anticipate a transition involving more than one owner have a buy-sell agreement in place. If your company does not have one, now is a good time to begin the process of creating one. Transitions are complicated. A good buy-sell agreement makes sure that all parties are on the same page about the value of the business, their own stake in it, and what happens in the event that ownership changes or is forced by a trigger event to change.
We are always here to help business owners make transition planning and the eventual transition as smooth and stress free as possible, so call us if you have any questions about how to prepare your business for the future.