Buysell Agreement 

What Is a Buy-sell Agreement?

A buy-sell agreement is a contract that has provisions concerning the transfer of shares of a partner who dies or leaves a business. Oftentimes, a buy and sell agreement demands for the share to be open for sale to the surviving partners of the company. Note that a buy-sell agreement is also referred to as a buyout agreement. This agreement is commonly used by businesses such as corporations, partnerships, and even sole proprietorships for the transfer of ownership to be smooth. According to Investopedia, there are two common types of buyout agreements: the cross-purchase and redemption agreement. In a cross-purchase contract, the surviving owners of a business have permission to buy the available share. On the other hand, in a redemption contract, the company itself buys back the share of a former co-owner. In the case of a sole proprietor who dies, a “key employee” may become the successor of the business. A key employee is a worker with a large percentage of ownership or is an employee with major decision roles in the business.

Reasons Why Having a Buy-sell Agreement for Your Business is Important

There are many scenarios that you may not want to happen in your company if you and your partners don’t agree to sign a buy-sell contract. For example, the wife or kid of your partner may become a co-owner, or a bank may own a big stake in your business. The company you’ve worked hard for years might end up on someone who didn’t even work for it. Well, these are only possibilities. So, here are four more reasons why you should have a buy-sell agreement for your company.

Fair value. In a general sense, fair value is the potential value or price of a share. A buy-sell contract puts in place the fair value of a co-owner’s share, which can be useful if one owner remains and the other one leaves the business. Having a fair value for all shares beforehand will prevent conflicts among partners since the numbers have been set ahead. Also, you’ll lessen the risk of a partner, or successor, to ask more money than the true worth of the share.Exit plan. Losing a partner in business can be problematic sometimes, especially if you don’t have a buy-sell agreement. It can be difficult for a partner who wants to leave to agree on split terms if there are no written provisions concerning it. For that reason, a buy-sell contract is crucial because it lays out a foundation for business partners to follow in case they want to leave. Don’t risk and waste money by being unprepared.Company interests. With a written document at hand, you will keep your company’s interest within or with the remaining owners, and you will prevent outsiders from entering your business. A buy-sell agreement is similar to the last will that determines who will own your money, property, or belongings after you die. It sets out who has the right to get your share of the business if you die or if you decide to sell or trade it. If you neglect using this agreement, a family member of your former partner may take a portion of your company without any idea of what to do with the share.Business continuity. Illness, death, or sudden sale of a share can cause some trouble for your business if you don’t have a buy-sell agreement. These factors can disrupt the operation of your business, that is why having a contract will guard you and your fellow partners against the challenges they create. A contract will guide your company on how things should be done if these unexpected events happen.

How to Prepare a Buy-sell Agreement for Your Company

A reliable buyout agreement will include a valuation statement, terms and conditions, and tax arrangements. You might need to meet with the shareholders or your business partners, business accountants, and an expert valuator to set up a buy-sell agreement. So, here’s what you have to do.

Step 1: Prepare the Contract as Early as Possible

Just like all the other contracts you have to sign with your business partners early on, preparing a buy-sell contract as early as possible is vital. Though you can set the agreement later on, it’s still better to be done with it from the very beginning. With an agreement signed, the process will be less complicated if unexpected events happen in your business.

Step 2: Set Your Terms and Conditions

The contract you create should be specific, measurable, attainable, realistic, and timely for your business. Merely creating a buy-sell agreement for the sake of duty is not enough. Contract stipulations should not only concern valuation but also ownership. Moreover, a buy-sell agreement should detail possible events that can trigger a company’s sale so that lenders won’t take advantage of the company in case of bankruptcy.

Step 3: Get Life Insurance Policies

Usually, business partners get life insurance policies before they sign buy and sell agreements. This is to ensure that the remaining partners have money to purchase the share of an ill or a deceased co-owner. You as a shareholder should have the money to buy out an available share with the assistance of life insurance policies.

Step 4: Incorporate a Valuation Statement

It is crucial for your document to have a valuation clause because it will determine how your stake will be calculated if you plan to leave the company. Some companies set their formulas in their agreements, while others ask help from an expert valuator at the moment of the sale or succession.

Step 5: Don’t Forget to Input Tax Arrangements

Estate taxes are inevitable if you sell your share of the business, and the same is true if your heir or successor trades the share they get from you in the future. So, you will want to have a fair and conservative formula for valuation in your contract. You may also include in the agreement if taxes are part or excluded in a sale.

buy-sell-agreement

FAQs

Can a former spouse of a co-owner own a portion of the business after divorce?

This depends on which state your business belongs to and what marital property law it follows. If the law in your state follows a “community property law” (e.g., Arizona, Nevada, California, etc.) then the properties that a married couple has acquired are regarded as common property. After divorce, the common property is divided between the husband and wife. Therefore, an ex-husband/wife of a former co-owner may ask for a share in the business. Because of such law, a buy-sell agreement will come in handy in case a co-owner decides to divorce his/her spouse.

If a partner files for bankruptcy, will it affect the whole company?

If the provisions, stipulations, or conditions in your buy-sell contract are incomplete, then yes, a partner who files for bankruptcy will have a big impact on your company. If a shareholder cannot cover for his bankruptcy, then a trustee may dissolve the company and use the money or profits of the business to repay the debts of a partner. Therefore, carefully laying out the conditions of a buy-sell agreement is crucial. Normally, a co-owner who plans to file for bankruptcy must notify his/her other co-owners, so that the company can take the option of buying back the share of a bankrupt co-owner.

Can you avoid estate tax by using a buy-sell agreement?

Yes. With a buy-sell agreement, you may reduce or even avoid estate taxes at the time of your death. One example is when you decide to pass on your share of interest to a wife or kid after your death, then you can avoid owing estate tax entirely. Additionally, if you have a valuation formula that lowers the value of your ownership, then your estate tax will be lesser after your death. To pull out the best options, it is good to ask assistance from a tax lawyer.

What are the common methods used to determine the value of a share?

The following are common methods used to know the price of a share: (1) Setting a fixed value, (2) asking help from an appraiser, (3) and utilizing a formula. In case the owners cannot come into terms concerning the value of a share, they can agree to the following instead: (1) The valuation of the previous year will be followed. (2) The company’s accountant will decide the value based on the contract’s formula. (3) The shareholders will choose an appraiser to calculate the fair market value.

Can a buy-sell agreement be used to buy and sell a business also?

No. A buy-sell agreement has nothing to do with selling or buying a company. Bear in mind that a buy-sell contract is a legally binding agreement between co-owners, members, or shareholders of a partnership, an LLC, or a corporation. The agreement addresses when an owner can trade his/her share, who may purchase the share, and how much the share’s price will be. A buy-sell agreement decides the process to take when a co-owner gets ill, retires, goes bankrupt, gets divorced, or dies.

It is hard to imagine companies without buy-sell agreements, especially huge companies with many members. If one member leaves, another may come to take his/her place, whether it be an outsider or a family member. This is not practical for a business whose goal is to expand its sales in cooperation with its partners or co-owners. Therefore, having a buy-sell agreement at hand is very important, especially when a major shareholder, a CEO, or even an ordinary member dies or leaves the business.