What is a buy-sell agreement?
Contrary to popular belief, a Buy-Sell Agreement is not about buying and selling companies. Rather, it is a binding contract between business owners about the future ownership of the business in the event of the death, disability, divorce, bankruptcy or retirement of one of the shareholders. Shareholders wisely include these provisions in a written document called a Buy-Sell Agreement or Shareholder Agreement.
This type of an agreement is found with the owners of a closely held business to allow for the disability, abandonment of the business, or untimely death of any of the owners. The agreements describe the provisions by which an owner’s share of the business will be redeemed. Buy-sells can be funded with disability and life insurance or they may be unfunded and, therefore, rely on the cash flow of the business to fund the buy out. Providing liquidity for the estate of the business owner is often the reason for the formation and execution of a buy-sell. There are different types of buy-sell agreements and the most common agreements are redemption agreements, cross-purchase agreements or a hybrid wait-and-see buy-sell agreement. It is not uncommon to see a separate trust or partnership formed to hold insurance that is used to fund a buy-sell agreement. These decisions and others are reviewed with the client during a counseling session as part of their business planning process.
A “buy-sell” agreement is the name given to the document that is intended to set forth the exit plan for shareholders or partners. A well written document will provide specific direction for an equity holder who needs to disentangle him or herself long before the only options are retirement, bankruptcy or an expensive business divorce. The document will determine: if the exit or decision to cease operations has to be unanimous; if a purchase by co-shareholder or co-partner is required; how long a disabled shareholder or partner has to be carried; if a spouse or other family member can inherit an equity interest in the event of death of a shareholder or partner; and, if a transfer of equity to a third party is permitted without the consent of the surviving shareholder or partner. The decision to exit, or need to see your co-shareholder or co-partner exit, may not be voluntarily. If discussed and planned before the fact, it doesn’t also have to be messy.
