Purpose of a Buy-Sell Agreement

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Do you have a business partnership or are you considering forming one? Owners of closely held businesses and partnerships should be concerned about their partners. What happens if one dies, becomes disabled, bankrupts or divorces? What would happen if your partner suddenly left the business and wanted their share of the business? A buy-sell agreement would address the foregoing possibilities.

A buy-sell agreement, also known as a buyout agreement, is a legally binding agreement between co-owners of a business that governs the situation if a co-owner dies or is otherwise forced to leave the business, or chooses to leave the business.

A Buy-Sell agreement can both ensure the continuing ownership and management of the business without having the departing owner’s family forced upon the remaining owners. It can also provide an exit strategy and fair compensation for a departing owner. A buy-sell agreement is not only an essential business and planning tool for any small business, it also establishes a valuation method and payment terms for unfortunate events should they arise.

Still not sure how a buy-sell agreement could benefit your business? These following trigger factors may change your mind.

Death

If your business partner ever passes away, you’ll want to have a buy-sell agreement in place so that a buyout can be made on the partners’ ownership. The terms of the buy-sell agreement include the disability determination and valuation of the interest. It also has the terms of payment to the owner or the estate and the mechanism and terms of buyout.

Sell Interest to a Third Party

Should an owner desire to sell their share of the business to a third party, the terms of a sell to a third party are contained in the buy-sell agreement and options of the sale are included in the agreement.

Buyout

In case of a desire to sale or for retirement, one partner may want to sell their interest in the company. The terms of this sale can be encompassed in the agreement. A buy-sell agreement can resolve the terms of the purchase and sale of the remaining members/partners. The terms will often provide for a down payment with installment payments over a number of years at a defined rate of interest contained in the agreement.

Divorce

Personal divorce can result in the potential of a new partnership with the ex-partner’s spouse. This is generally not the desire or intent of the original partnership. In community property states, this potential is much more prevalent. It is critical to have a buy-sell agreement to protect and preserve the continuity of the company should one of the owners get divorced.

Bankruptcy

The bankruptcy of an owner can result in the owner’s interest passing to a third party. In a bankruptcy, the result could be that the other owners may end up having the option to purchase the interest of bankrupt owner. This puts the remaining owners at a disadvantage because the value of the company can be set by the third party. The buy-sell agreement will give the business and the other owners the option to compel the affected owner to sell his or her interest to the business entity or the other owners in accordance with the valuation method and payment terms provided for in the agreement.

Valuation

The valuation of the interest being purchased under the terms of a buy-sell agreement is a critical issue for both the selling owner and the purchasing business entity or other owners. The valuation method must balance the competing interests of the selling owner, who desires a high valuation, and the purchasing business entity or other owners, who desire a low valuation. The method of valuation can be chosen by the partners utilizing the Book Value, Appraisal, Capitalization of Earnings or Agreed to Value.

Disability/Life Insurance

For a potentially disabled owner, disability insurance can be utilized to fund a buyout and should a partner decease, life insurance can be used.

In conclusion

With all these factors, you can see that a buy-sell agreement is not only an essential business and planning tool for any closely held business, it also establishes a valuation method and payment terms for certain events should they arise. Disputes are eliminated and litigation can be averted with the utilization of a well-planned buy-sell agreement.

Considering a buy-sell agreement for your partnership? The experts at NCH, along with our in-house law firm, can help. Call NCH today at 1-800-508-1729 to get started.


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