What Is a Buy and Sell Agreement?
A buy and sell agreement is a legally binding contract that stipulates how a partner's share of a business may be reassigned if that partner dies or otherwise leaves the business. Most often, the buy and sell agreement stipulates that the available share be sold to the remaining partners or to the partnership.
The buy and sell agreement is also known as a buy-sell agreement, a buyout agreement, a business will, or a business prenup.
- Buy and sell agreements stipulate how a partner's share of a business may be transferred in the event of the partner's death or departure.
- Buy and sell agreements may also establish a method for determining the value of a business.
- The two most-common buy and sell agreements are cross-purchase, and redemption; some agreements will combine the two.
- Cross-purchase agreements allow remaining owners to buy the interests of a deceased or selling owner.
- Redemption agreements require the business entity to buy the interests of the selling owner.
How a Buy and Sell Agreement Works
Buy and sell agreements are commonly used by sole proprietorships, partnerships, and closed corporations in an attempt to smooth transitions in ownership when each partner dies, retires, or decides to exit the business.
The buy and sell agreement requires that the business share be sold to the company or the remaining members of the business according to a predetermined formula.
In the case of the death of a partner, the estate must agree to sell.
Understanding Buy and Sell Agreements
There are two common forms of agreements:
- In a cross-purchase agreement, the remaining owners purchase the share of the business that is for sale.
- In a redemption agreement, the business entity buys the share of the business.
Some partners opt for a mix of the two, with some portions available for purchase by individual partners and the remainder bought by the partnership.
In order to ensure that funds are available, partners in business commonly purchase life insurance policies on the other partners. In the event of a death, the proceeds from the policy will be used towards the purchase of the deceased's business interest.
When a sole proprietor dies, a key employee may be designated as the buyer or successor.
Partners should work with both an attorney and a certified public accountant when crafting a buy and sell agreement.
Key Considerations in Buy and Sell Agreements
Buy and sell agreements are designed to help partners manage potentially difficult situations in ways that protect the business and their own personal and family interests.
For example, the agreement can restrict owners from selling their interests to outside investors without approval from the remaining owners. Similar protection can be provided in the event of a partner's death.
A typical agreement might stipulate that a deceased partner's interest be sold back to the business or remaining owners. This prevents the estate from selling the interest to an outsider.
In addition to controlling ownership of the business, buy and sell agreements spell out the means to be used in assessing the value of a partner's share. This can have uses outside the question of buying and selling shares. For example, if there is a dispute among owners about the value of the company or of a partner's interest, the valuation methods included in the buy and sell agreement would be used.