A lot of SBOs have probably heard the term “buy-sell agreement,” but aren’t really sure what they are, how they work, or why they would need one.
What is a buy-sell agreement? Think of a buy-sell agreement as a sort of prenuptial between business partners. It is easier to negotiate the terms of a departure when everyone is friendly and optimistic than it is to negotiate those same terms after feelings are hurt or someone is unhappy with the direction of the company. It is a way to protect the business from a litany of threats discussed below.
How does a buy-sell agreement work? A typical buy-sell agreement is incorporated into a company’s governing documents or it can exist as a stand alone agreement. The agreement will define the circumstances that trigger its effect. The agreement will define who the eligible purchasers are. The agreement will provide a method for valuing the business and the terms for conducting the purchase.
Why would you want a buy-sell agreement? There are a number of reasons why business owners might want a buy-sell agreement but they all boil down to protecting business. The buy-sell also ensures that that when one person enters a business relationship with another, they have clearly defined all those who may one day gain an interest in the company through unforeseen events.
For instance, the divorce of a business partner might trigger a requirement that the separating spouse sell any interest awarded as part of the divorce back to the business. A partner’s decision to seek dissolution could trigger a buy-sell agreement, allowing the business to continue on. The death of a partner could trigger a buy-sell agreement, ensuring the business interest is not transferred to the estate.
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