Buy-sell agreements are contracts among business owners that specify what happens to an owner’s interests upon the occurrence of certain life-altering trigger events. They are designed to protect each owner’s interests, preserve their value and marketability, restrict transferability to desired individuals only, prevent future legal disputes, ensure business continuity, make funds available to the departing owner and his family to pay living expenses and taxes, and provide certainty and peace of mind to all involved.
Good buy-sell agreements specify not only events that trigger mandatory or optional buy-outs but also who may and may not purchase a departing owner’s interests, how the buy-out will be funded, and a formula or procedure for establishing fair value. Such agreements also often include covenants not to compete, confidentiality clauses, and other provisions designed to protect the business as a going concern.
Trigger events commonly include death, physical or mental disability, retirement, loss of a professional licence, termination of employment, an owner’s offer to sell or a third-party’s offer to purchase all or a portion of the owner’s interests, divorce, bankruptcy, insolvency, and dissolution of a corporate owner. And typical funding vehicles include life and disability insurance policies.
There are several basic buy-sell structures, including cross-purchase agreements that enable remaining owners to purchase the departing owner’s interests, entity-purchase agreements that require the business to redeem those interests, wait-and-see agreements that allow the decision between a cross-purchase and entity-purchase to be made at the time of the trigger event, and no-sell agreements that allow the remaining owners to retain control of the business while permitting the departing owner and his family to benefit from the continued prosperity of the business. Each of these structures has advantages and disadvantages, including variations in flexibility, ease of administration, tax consequences, and other costs to both the individual and the business.
However, regardless of the structure employed, every business can benefit from a solid buy-sell agreement, be it a corporation, LLC, partnership, or even a sole proprietorship. In fact, if you are a co-owner of a business and don’t have a signed, updated buy-sell agreement, you are leaving your business interests and your family’s future welfare to chance.