Basics of a Buy-Sell Agreement

Businesses need a plan for events beyond their control. This includes the death of owners in a business, the divorce of key personnel, an accident that causes an owner to become incapacitated, or other contingencies. When these events happen, the other owners and interested personnel in the business need to ensure their ownership interests are protected and that the business will continue running smoothly.

That is where a buy-sell agreement is used. A buy-sell agreement identifies what events trigger the operation of the agreement. The buy-sell agreement defines the parameters of the transfer of ownership, including:

• Who has the right to buy the seller’s (owner’s) interest?
• The value/amount that should be paid to the seller
• How will the buyer secure the funds for the purchase and what are the time limits for obtaining funding?

The agreements may differ depending on the type of interest.

• Typically, with legal assistance, owners of a small business will draft a buy-sell agreement contract.
• Partners usually incorporate a buy-sell agreement into their partnership agreement.
• Corporations usually define who can buy stock in the company depending on the type of stock.
• Corporate bylaws define the parameters of any change in the board of directors of a company, the officers of the company, and the management of the company.

Buyers of small businesses can be other owners, employees, or third parties. Without a buy-sell agreement, a spouse may become a new owner. The business could die while the remaining owners of a business and their heirs fight over the business in court. Even sole proprietorships should consider a buy-sell agreement if the company has a valuable employee who might want to continue the restaurant, retail store, or service business when the owner dies or can’t continue ownership.

Triggering events

Every buy-sell agreement should identify what events can trigger the agreement. Generally, the following triggers should be identified in the agreement.

• The death of an owner. Otherwise, the owner’s interest will be handled by her or his estate. The heirs may not have the same business goals as the other owners.
• A disability of a partner or owner. The definition of a disability should be clear. Someone shouldn’t lose their interest because he or she broke an arm.
• Someone shouldn’t automatically lose his or her business due to a divorce. Often, it is to the advantage of the other spouse that the other owner or owners continues the business. Still, the possibility that a spouse may acquire an interest in a company should be addressed. Often, the other owners may be given the right to buy out the spouse’s interest.
• The personal bankruptcy of an owner can affect the business too. The other owners should be able to buy out the owner’s interest so that the creditors of the owner don’t take over the business. The owners will need to pay fair market value for the owner’s interests and obtain a bankruptcy court’s approval of the transfer and sale of that interest.
• Retirement or a voluntary leave. A buy-sell agreement is ideal for an owner who wants to sell their interest and get a fair value for it – while protecting the other owners. The agreement can include the right of the owner to continue working as an employer or manager at a salary.

Another trigger includes conflicts between the owners that cannot be resolved on a friendly basis.

Common buyout types and terms

A buyout can be conditioned on giving the remaining owners the first option to buy out the owner’s interest. The buyout should have a valuation method such as a cash figure, adjusted for inflation, or some specific dollar amount – so there isn’t a contest about the value. Standard valuation methods include a formula set up by the owners or a professional appraisal from someone experienced in your type of business.

Some of the traditional types of buyout plans are:

• Cross purchases plans. Here, each owner agrees to buy an owner’s interest when a triggering event occurs. These plans are frequently funded by insurance the owners carry on each other owner. These plans are generally better if there are three or less owners.
• Entity redemption plan. Here, the business buys out the owner’s interest instead of the individual owners. It’s referred to as a stock redemption plan if the business is a corporation.
• A one-way plan. Here, the buy-sell agreement is set up so that only one person – such as a spouse, child, or employee – is given the ability to buy the owner’s interest.

There are many other considerations an experienced Nashville buy-sell agreement lawyer will review such as business practicalities, business tax issues, cost factors, and other issues.

The Law Office of Perry A. Craft PLLC has been advising business buyers and sellers for decades. We review what business structures work best, the goals of the owners, business succession plans, and how to transfer business interests – among many other business issues. For help preparing a buy-sell agreement, call the Law Office of Perry A. Craft PLLC at 615.239.1899 or fill out our contact form to make an appointment.