10 Things To Know About Buy-Sell Agreements For Business Owners

1. What Is a Buy-Sell Agreement?

A buy-sell agreement is a legally binding contract that outlines how ownership interests in a business will be transferred if an owner leaves the business. It acts as a roadmap for managing ownership transitions, minimizing disputes, and protecting the business’s stability.

2. Why Your Business Needs One

Without a buy-sell agreement, the departure of a business partner—whether due to retirement, death, or disagreement—can lead to chaos. A clear plan ensures that ownership transitions happen smoothly and fairly, protecting both the remaining owners and the departing partner’s heirs.

3. Triggering Events

Buy-sell agreements are activated by specific triggering events. Common triggers include:

• Death or disability of an owner.
• Retirement or voluntary exit.
• Bankruptcy or divorce of an owner, which might involve a court-ordered sale of their shares.
• Disputes among owners.

4. Types of Buy-Sell Agreements

There are three main types of buy-sell agreements:

• Cross-Purchase Agreements: Co-owners agree to purchase the departing owner’s share.
• Entity-Purchase Agreements: The business itself buys the departing owner’s share.
• Hybrid Agreements: Combines elements of both, allowing flexibility based on the situation.

5. How to Value the Business

A key part of any buy-sell agreement is determining the value of the business. Common methods include:

• Fixed Value: Owners agree on a set valuation, reviewed and updated periodically.
• Formula-Based: Valuation is based on a formula, such as a multiple of revenue or earnings.
• Third-Party Appraisal: A professional appraiser determines the value when a triggering event occurs.

6. Funding the Agreement

A buy-sell agreement is only effective if it’s properly funded. Common funding methods include:

• Life Insurance: Used to buy out the shares of a deceased owner.
• Disability Insurance: Covers buyouts if an owner becomes disabled.
• Cash Reserves: The business sets aside funds to handle buyouts.
• Financing: Borrowing funds to complete the buyout.

7. Avoiding Disputes

A well-drafted agreement prevents disputes by clearly outlining the terms for valuation, funding, and ownership transfer. Involving legal, financial, and valuation professionals ensures clarity and fairness for all parties.

8. Protecting Family and Heirs

A buy-sell agreement protects the interests of an owner’s family or heirs. For example, it ensures that the family of a deceased owner receives fair compensation without forcing them into business operations they may not be equipped to handle.

9. Regular Reviews Are Essential

Businesses evolve, and so should your buy-sell agreement. Regularly review and update the agreement to reflect changes in the business’s value, ownership structure, or other relevant factors. Life changes like marriages, divorces, or new partnerships may also require updates.

10. It’s a Team Effort

Creating a buy-sell agreement requires collaboration among legal, financial, and tax professionals. Their expertise ensures that the agreement is legally sound, financially practical, and aligned with the business’s goals.

Final Thoughts

A buy-sell agreement is more than just a legal formality—it’s a cornerstone of responsible business planning. By preparing for the unexpected, you can protect your business, maintain stability, and preserve relationships among owners and their families. If your business doesn’t have a buy-sell agreement in place, now is the time to consult with professionals and safeguard your future.