Despite what the name indicates, a buy sell agreement isn’t an agreement to buy and sell anything. Rather, it’s an agreement made by business co-owners to sell their interest in the business in certain circumstances. The buy sell agreement protects the remaining owner’s interest in the business if one owner gets divorced, becomes disabled, leaves the company, retires, or files bankruptcy, for example. The buy sell agreement spells out the specific situations that a co-owner can, cannot, and must sell their
Why A Business Would Have a Buy Sell Agreement
A buy-sell agreement can exist for any type of business: partnership, proprietorship, or corporation. Many people may think they can operate the business without a hitch, but you never know what could go wrong.
For example, what if your business partner divorces his spouse and the ex-spouse now claims to have financial stake in the company? The buy-sell agreement would spell out what happens in this situation. What if a partner decided they no longer wanted to be in business, but would sell their interest to a friend that none of the other partners has met? A buy-sell agreement would determine whether this can be done and explain the process for doing it. Buy-sell agreements can also prevent the bankruptcy court from liquidating the business if one of the owners files personal bankruptcy.
How to Valuate the Company
Before the two owners can come up with a price for buying/selling the departing owner’s business interest, the company needs to be appraised by a financial professional. That person would look at the business financials and decide how much the company is worth. Then, that number would be used to come up with a buy/sell price.
Because there can be some disparity in company’s valuation when it’s time for an owner to sell his interest, the buy sell agreement should have some type of arrangement for valuating the company when the time comes. Otherwise, the co-owners could use different financial professionals who come up with different valuations. The result is a disagreement on how much the remaining co-owner should pay for the departing owner’s interest. Agreeing to a valuation method beforehand reduces the risk of problems later on.
Various Terms of the Agreement
The buy-sell agreement could also set a fixed purchase price or a formula for determining price for a buyout. The agreement might state different buyout prices or formulas for different triggering events.
The buy-sell agreement should include details about how the buy-out payment should be structured. It can specify that the departing owner’s interest be purchased either by the remaining owner(s) or by the business itself. It might be unreasonable to expect the remaining owner to pay 100% of the buy out price all at one time. Instead, the agreement might call for a lump sum payment followed by periodic payments for a certain period of time.
Buy sell agreements might require business owners to have life and disability insurance coverage with the business named as the beneficiary. The benefit amount on the insurance would be a specific amount that’s agreed upon in the buy sell agreement. While life insurance proceeds are typically exempt from income taxation, depending on the type of business, life insurance proceeds could make the business subject to additional tax.
A business or tax attorney can help you prepare a buy-sell agreement. While it’s best to have the agreement in place before the business starts, it’s never too late to put one in place. It can keep you from having to go to court to resolve disputes and, more importantly, can keep your business in tact if something happens to one of the business owners or one owner decides to leave the business.