From Our “Ask a Question” Mailbag: “What’s a Buy-Sell Agreement, and do I need one to protect my business?”
Peter Klenk, Estate Planning Lawyer.
What’s a Buy-Sell Agreement?
If you’re a small business owner, consider what happens to your ownership interest in the company when you die or retire. If you’re in a partnership, should your share go to the remaining partners? To your children? To the highest bidder? What if you own a sole proprietorship? If any of these questions are relevant to you, you and your business can benefit from a Buy-Sell Agreement.
Also known as a business prenup, a business will, or a buyout agreement.
A Buy-Sell Agreement (also known as a business prenup, a business will, or a buyout agreement) is a binding contract that controls what happens to your share of a company when you die, retire, or upon some other predetermined event. There are numerous advantages to using a Buy-Sell Agreement. A properly drafted agreement will specify a set purchase price or purchase price formula. A well prepared buy-sell agreement offers protection against a volatile market and avoids complicated valuation issues down the road. Buy-Sell Agreements are also an effective means of keeping small businesses within the family and not sold off to strangers.
What Type of Businesses use Buy-Sell Agreements?
Buy-Sell Agreements are often used by sole proprietorships, partnerships, LLCs, and small, closely-held corporations. They come in three flavors: redemption, cross-purchase, and hybrid.
A Redemption Agreement typically requires the business entity to purchase your share at an agreed-upon price upon the occurrence of a triggering event (i.e., death, retirement, disability, divorce, or loss of professional license). Of course, the agreement also obligates you (or your estate) to sell to the company. Redemption Agreements don’t work for sole proprietorships since there is no distinction between the business and the owner.
A Cross-Purchase Agreement is like a Redemption Agreement with a critical difference. Instead of requiring the business entity itself to purchase your share, the agreement obligates the remaining owners of the company to buy you out proportionally. Sole proprietors can use a form of the Cross-Purchase Agreement, known as a One-Way Buy-Sell Agreement. If you can find a willing buyer (your employees perhaps?), that buyer agrees to purchase your sole proprietorship upon your death or retirement.
Hybrid Buy-Sell Agreements.
A Hybrid Buy-Sell Agreement combines elements from Redemption Agreements and Cross-Purchase agreements. For instance, a Hybrid Agreement might give the business entity and the other individual owners rights of a first and second refusal. In that case, the entity has an exclusive option to buy your business interest. But, if it declines, this gives the remaining owners the same opportunity.
Buy-Sell Agreements are flexible ways to plan for the future of your business. Feel free to contact our estate planning attorneys for a consultation. For more detailed information about Buy-Sell Agreements, see our main article, “Business Succession Plans: Everything You Need to Know.”
In Conclusion: What is a Buy-Sell Agreement, and do I need one to protect my business?
I hope you found helpful this short article addressing the question, What is a Buy-Sell Agreement? I have also included some links for more detailed information. If you are curious about Succession Planning, or other various planning techniques, contact us. Let our Buy-Sell lawyers help walk you through what can be a confusing process. In fact, feel free to contact our office for a free consultation.
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Attorney Andrew Barron wrote this article.