What is a buy-sell agreement?
Wills, life insurance, buy-sell agreements — no one likes to think about the “what-ifs” in their life, personal or professional. But, like it or not, they’re a critical safeguard.
So, how do you protect your business against the uncertainties of every day?
An aforementioned buy-sell agreement may be the answer.
If your business has multiple owners, a buy-sell agreement can protect your hard work by ensuring your company stays within your control if a partner leaves or passes away.
In this article, we go over the ins and outs of buy-sell agreements, so you know what’s ahead and can make the best choices for your business.
What is a buy-sell agreement?
A buy-sell agreement is a legal agreement between co-owners of a business that outlines what happens if one of them wants or needs to sell their share of the company.
This agreement typically details the scenarios in which a buyout can occur, like retirement, disability, or death, and lays the groundwork for the terms and conditions of the sale.
With a buy-sell agreement as your roadmap, you can hopefully avoid any conflicts during the ownership transition.
Let’s say one of you decides to retire, start another business, or join the circus.
The buy sell agreement template you worked on together will kick in and dictate how the remaining owners buy out the departing owner’s share.
Think of this as a way to safeguard your investment and ensure the stability of your business, like getting flood insurance after buying a house near a river.
A buy-sell agreement is an essential tool for any business with multiple owners looking to plan for the future. So, make sure you have one in place to protect your company and your friendships!
How does a business buy-sell agreement work?
A business buy-sell agreement typically works in the following way:
- A partner in the business decides to retire, exit the company, or, unfortunately, passes away.
- The buy-sell agreement kicks in, dictating that the business shares from the exiting partner be sold to the business or the remaining partners based on a predetermined formula. If death is the cause of their exit, the estate must first agree to sell.
Anyone who’s watched Succession knows business transitions can be tricky! Buy-sell agreements are used mainly by sole proprietorships, partnerships, and closed corporations to avoid uncertainty.
If none of these situations describe your business, you don’t have to worry too much about this happening.
What is the purpose of a buy-sell agreement?
A buy-sell agreement will undoubtedly make your life easier.
Besides knowing exactly what will happen if a partner leaves your business, you’ll benefit from having a business continuity plan prepared and ready to go when needed.
This will act as an exit strategy for each business partner, so they can make their own plans if and when required.
It will also allow you to establish a fair price for your partnership shares in advance of any issues.
On another note, a buy-sell agreement can save you from some awkward scenarios.
Without one, the spouse of a former business partner, their children, or even a bank could wind up taking their place.
Understandably, they may not have the skills or interest to help you run the business, putting you and any other partners in a bind.
What is a cross-purchase buy-sell agreement?
In a cross-purchase buy-sell agreement, the remaining partners agree to purchase the departing partner’s ownership interest at a predetermined price.
For example, if you and two friends open a business, and one friend decides to leave, you and the other would purchase their share.
The price is most often determined in advance through a business valuation process.
This is one of the most common buy-sell agreements and is often used in small businesses with only a few partners.
Once you go beyond three, the math involved in splitting and purchasing shares can get muddled.
So, if you have four or more partners, there are other better options available.
What is an entity-purchase buy-sell agreement?
One of those better options is an entity-purchase buy-sell agreement.
Also referred to as a redemption agreement, this is where the business entity itself agrees to buy back the ownership interest of whoever is leaving the business.
Let’s look at an example. There are four owners of a corporation, A, B, C, and D, and they invest in and finalize an entity-purchase agreement template.
Down the road, when A retires, the corporation purchases A’s ownership interest in the business according to their predetermined agreement.
As we said earlier, this is an excellent choice for businesses with more than three partners.
It’s a cleaner option if multiple individuals are involved and can help avoid legal issues and conflicts.
What’s the relationship between buy-sell agreements and life insurance?
Buy-sell agreements and life insurance are often interconnected For example, life insurance can provide the funding needed to execute a buy-sell agreement.
By purchasing life insurance policies on each owner’s life, the business or other partners can ensure the necessary funds are available in the event of a death or long-term disability.
The policy proceeds can be used to buy out the deceased owner’s interest, as specified in the buy-sell agreement.
This way, the remaining owners maintain control of the business without having to come up with a large sum of money at a difficult time.
Check out PandaDoc’s buy-sell agreement template
Creating, drafting, and approving the perfect buy-sell agreement for your business won’t happen overnight.
You’ll need a lawyer, a tax professional, and the right document workflow software to see you through the process.
With PandaDoc, you can see your buy-sell agreement through every step of the creation process, from document generation, to approval, to signing.
Every step is covered and every stakeholder is included.
Buy-sell agreements are important for your business, and with PandaDoc, you can make sure they’re done right.
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