What Is a Buy-Sell Agreement, and Does My Business Need One?
Business partnerships are, in many ways, like marriages. When starting a business with one or more partners, you become linked to them, dependent on them to make decisions about the future of your company. Many married couples choose to create prenuptial agreements to save themselves time and money should the relationship end. It is even more critical that business partners create agreements dictating what should happen if one partner dies or wishes to leave the company. A buy-sell agreement can protect you from losing control of your business, should partners leave or tragedy strike.
What does a buy-sell agreement do?
Buy-sell agreements, also known as buyout agreements, specify what will happen in the event that a partner voluntarily or involuntarily leaves the business. These agreements assist the remaining partners to remain in control of the company, allowing it to carry on its business functions undisturbed, should a partner leave. Buy-sell agreements usually include terms that govern what should happen if one of the partners dies, chooses to sell their ownership interest or shares, gets a divorce, files for bankruptcy, or becomes disabled. Partners can also choose to include additional events that will trigger a buyout of a partner’s shares. Additionally, buy-sell agreements can outline when a partner may be permitted to sell his or her shares of a business to outsiders. Buy-sell agreements should not only determine when and how a partner will be bought out, but also how much the partner will receive for their interest, and how the purchase price will be calculated.
How buy-sell agreements work
Many buy-sell agreements include funding provisions for buyouts, as well, such as insurance policies that facilitate the type of buyout described in the agreement, or an agreement to use accumulated earnings to make the purchase. Two of the most common types of buyout purchase agreements are:
Cross purchase: In this form of purchase, the partners who remain with the business agree to buy the departing partner’s shares at a predetermined price. In this case, a partner might purchase a life insurance policy on their business partner that would allow them to purchase the shares upon the partner’s death.
Entity purchase: With an entity purchase, the business itself buys out the departing owner. Here, the business itself would purchase a life insurance policy on the partners to facilitate the buyout, if insurance is being used to fund the purchase.
Some businesses choose a hybrid of these options, with partners and the business buying out departing partners. While form buy-sell agreements exist, they often fail to represent the unique needs of an individual business and its partners. Hiring a California business attorney to draft your organization’s buy-sell agreement is recommended.
If you’re starting a business or have an existing business in Southern California and want to ensure that your personal and professional interests are protected, contact a knowledgeable and effective San Diego business attorney at Esprit Law for a complimentary consultation, at 619-876-0503.