Business Partners’ Buy-Sell Agreement: What is it & Why is it So Important?

Business Owners Buy-Sell Agreement

Business Partners’ Buy-Sell Agreement : Creating a buy-sell agreement is one of the most important things you can do to protect your rights to your business, ensure the longevity of your company, and avoid burdening your loved ones if you should ever become unable to continue managing it. It’s as essential as creating a will. Yet, just one-in-ten business owners have taken this crucial step, according to Forbes research.

On this page, we’ll go over what a buy-sell agreement is, how it works in various scenarios, and what to include in yours.

What is a Buy-Sell Agreement Between Partners?

Sometimes called a buyout agreement, a business prenup, or a business will, a buy-sell agreement is a legally binding agreement that stipulates how a business owner’s share of a company is reassigned if he or she leaves the business. It can address a variety of trigger events, such as:

  • Death, Permanent Disability, or Incapacitation: Ensures ownership stays within the company and saves the deceased owner’s family from having to sort out a business they don’t understand and/or don’t want.
  • Retirement: Ensures there’s a plan in place to end the partnership agreement amicably when one partner is ready to retire.
  • Exit: Helps avoid conflict if a partner wants to sell or leave for any reason.
  • Involuntary Seizure: Because ownership of a company is an asset, judges can sometimes rule that an owner’s stake be awarded to another party or sold. For example, a spouse might get some or all of an owner’s share in a divorce. Courts will sometimes get involved in debt-related situations or bankruptcies too.

Cross-Purchase Agreements vs Redemption Agreements

There are two common types of buy-sell agreements: cross-purchase and redemption. Although business partners can choose just one method, a mix of the two can be used as well.

  • Cross-purchase: The remaining owners purchase the available share.
  • Redemption: The business entity purchases the available share.

Can a Sole Proprietor Enter into a Buy and Sell Agreement?

Oftentimes, people think of buy-sell agreements in terms of partnerships or closed corporations, but they’re just as important for sole proprietorships too. In these cases, a key employee is usually given the option to purchase the business. It ensures there’s a continuity plan in place and that the business will continue to operate even if the business owner has passed away.

What Happens if You Don’t Have a Buy-Sell Agreement?

If there’s no buy-sell agreement in place and a sole proprietor passes away or becomes incapacitated, the business usually passes to the spouse or next of kin. It may also be given to the owner’s guardian to manage. It’s treated no differently than any other personal property owned by the individual.

The same is true in the case of death or incapacitation in a partnership. However, these arrangements also have challenges with retirement, exit, and divorce situations too. If the parties involved cannot agree, and the new owner has the right to sell, he or she may do so against the other partner’s wishes. If the situation prevents a sale, it may become a court matter. In these cases, judges often rule that the business must be dissolved or sold, debts paid, and any proceeds be split accordingly.

What if the Partner or Key Employee Can’t Afford to Buy the Available Share?

Buy-sell agreements typically address this through life insurance policies. Those who will purchase shares take out a policy on their partner. That way, if the business or share would ordinarily pass through to a relative or an estate, the intended shareholder can purchase it.

What Should a Buy-Sell Agreement Include?

Buy-sell agreements can be customized to the needs and wishes of business owners and will vary based on factors like the number of owners, as well as the type, size, and strength of the business. For that reason, it’s always a good idea to touch base with an attorney to ensure everything is addressed properly. A few things that are routinely included in buy-sell agreements are outlined below.

Valuation Clause

It’s important to determine how the business valuation will be handled ahead of time. Sometimes business owners determine a buyout price in advance or create their own valuation strategy. As a business grows, a valuation expert is usually brought in at the time of sale, and the purchase price is set at fair market value.

Buyer Limitations

Some contracts offer remaining partners the right of first refusal, meaning the remaining partner or partners need to be offered the available stake but don’t necessarily have to take it. Others get a bit more detailed about who the departing party can sell to. For example, a partner may only be allowed to sell to a private party rather than a corporate entity.

Payment Guidelines

In some situations, such as retirement or permanent disability, it may be better for all parties involved for the departing owner to have a slower exit. Rather than pay in one lump sum, the partner buying out the departing partner may make payments over a set period of time. It can reduce the strain on the buying partner while giving the departing partner a source of income.

How Can I Create a Buy-Sell Agreement?

There are lots of buy-sell agreement templates online. These can help if you’re in a bind and want something on paper fast, but it’s generally best to have an attorney draft a buy-sell agreement for you. That way, you can be sure it’s tailored to your company and doesn’t leave any ambiguous terms that might create loopholes or make it difficult to transfer ownership later.

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Disclaimer: The information provided in this article does not, and is not intended to, constitute legal or accounting advice; instead, all information, content and materials available are for general informational purposes only and may or may not be up to date. You should seek appropriate counsel for your own situation

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