What is a Buy/Sell Agreement, and Does my Small Business Really Need One?
A Buy-Sell Agreement (sometimes referred to as “buy-out agreements” or “business continuation agreements”) is a contract governing what happens to a business co-owner’s interests in a company when the business co-owner dies, becomes disabled, or leaves the business. You might think of a Buy-Sell Agreement as a “pre-nup” or an estate plan for sole proprietorships, partnerships, and close corporations. An effective Buy/Sell Agreement will establish (1) who can purchase the co-owner’s interest, (2) the price at which that interest may be purchased, and (3) how the business or partners will pay for the co-owner’s interest.
The Buy-Sell Agreement will identify specific conditions which may trigger a sale of the co-owners interests. These conditions almost always include death, disability, divorce, departure, deadlock, disagreement, and default. These triggering conditions are often labeled the “D’s of Buy-Sell Agreements.”
By way of example, Ally and Bert are co-owners of the Main Street Tavern, each holding a 50% interest in the Tavern. If Bert died before the Tavern formed a Buy-Sell Agreement, Bert’s heirs may end up as partners of the Tavern, which Ally may not want. If, instead, the Main Street Tavern has an effective Buy-Sell Agreement in place, upon Bert’s death, Ally could have the first opportunity to purchase Bert’s interest in the Tavern at an agreed upon price, or at a price to be calculated using a pre-determined formula or appraisal method.
Suppose Ally is sick of being in business with Bert. Without a Buy-Sell Agreement in place, Ally could sell her 50% interest in the Tavern to Bert’s arch-nemesis Craig, which would be major trouble for the future of the Tavern. On the other hand, an effective Buy-Sell Agreement could force Ally to offer the interest to Bert before she took her shares to the marketplace to sell to someone else.
Finally, suppose Bert and his wife Darla divorce. Without a Buy-Sell Agreement in place, Darla could receive some of Bert’s interest in the Tavern as part of the divorce settlement. If divorce is one of the triggering conditions in an operational Buy-Sell Agreement, Darla may be estopped from receiving any interest, Darla’s interest may automatically become non-voting interest, the interest which Darla might have received may revert to Ally, or Ally may at least have the opportunity to purchase Darla’s interest.
Every small business needs a Buy-Sell Agreement in place. Without one, the business, partners and heirs may suffer from internal fighting, and the business may lose some of the goodwill the partners worked so hard to build, or the business may dissolve. In any case, having an effective Buy-Sell Agreement will give comfort to co-owners and their families, and the business can continue to prosper should one of the dreaded “D’s” strike.
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