by: John B. Palley, Attorney
Buy-sell agreements, or buyout agreements, are agreements between co-owners of a business. The agreement covers what happens if one of the owners dies, becomes disabled or leaves the business for some other reason. They are generally between partners of a partnership, shareholders of a corporation or members of an LLC. They are typically used in smaller closely held businesses. They are similar to premarital agreements that two people many enter into before marriage; of course, this makes sense since a business partnership is a lot like a marriage.
The list of issues that can be included in a buy-sell agreement are great. However, the most common event dealt with is death. Thus, the inclusion of buy-sell agreements here on our estate planning page is accurate. A buy-sell agreement is a part of estate planning for a business owner. It is very important as often the business is one of the most valuable assets a person owns. When dealing with death it is common to include “funding” via life insurance. That is, life insurance to buy out the deceased partner’s share of the business.
The two most common approaches are a cross purchase agreement and an entity agreement. In a cross purchase agreement each partner buys life insurance on the other partner’s life. This is generally favored by businesses with a small number of partners. For example, in the typical two man partnership a cross purchase agreement makes excellent sense. However, when there are a number of owners involved then an entity plan makes more sense. In an entity plan the business buys life insurance on each owner. If an owner dies the money gets paid to the business and then the business buys out the decedent’s share of the business.
The issues we commonly see dealt with in a buy-sell agreement are:
- Provisions for buy out if an owner dies;
- Provisions for buy out if an owner becomes disabled;
- Provisions for buy out if an owner leaves the business for some other reason (bankruptcy, divorce, etc…);
- Provisions for buy out if an owner wants to sell his share of the business;
- What events trigger a buyout other than state above;
- A calculation of what price will be paid for the business interest;
- What terms the buyout will be (cash, promissory note, etc…);
- And other such terms.
A buy-sell agreement is a complex business contract. It is generally not appropriate to utilize a simple “form” as there are far too many issues for a form. An experienced business or estate planning attorney should be used.
Remember, just like when a person gets married, everything looks rosy when you start a business partnership. However, I imagine more business partnerships break-up than marriages do. When a business break up happens it can be messy. An improperly drafted document can cause huge problems at that time!
Obviously this is an overview but hopefully it gives you a thought on some issues to think about.
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