What Is a Buy-Sell Agreement and Why Is It Vital for a Successful Partnership?

For entrepreneurs starting or building a business with a partner or partners, one of the must-haves is a buy-sell agreement. This agreement establishes protection for all parties and the company should something happen or if an exit occurs for one of the business partners. Without such an agreement, many variables can emerge, such as a family member or other party that takes ownership or a controlling stake, and perhaps without any initiative for success.

Evaluate and Ensure Fair Value for the Business

A buy-sell agreement ensures the stakeholders all agree on the business’s fair value either by the total value or through earnings, sales, and assets. The agreement prevents any unfortunate events in the future where questions arise on valuation. This part of the agreement needs to be continuously updated, as each business’s valuation will change over time. Be careful in another area of how the valuation clause in the contract is worded, especially between what is considered a “fair value” and a “fair market value.” Other terms can also have different implications on the actual value understood by the business ownership, attorneys, financial advisors, and other parties during a triggering event of a buy-sell agreement.

Provide a Structure for the Agreement

Many businesses have chosen various structures for a buy-sell agreement. However, there are two common structures used, an entity-redemption or a cross-purchase structure. Simply put, an entity-redemption structure ensures the business holds the liability to purchase the ownership stock or interest of the partner leaving the company. In comparison, the cross-purchase structure allows for each remaining owner to acquire the stock previously owned by the partner leaving the company. With any structure, business owners may elect to write into the agreement provisions where a certain percentage of stock is transferred to a surviving benefactor or offered to potential investors.

Make Sure the Agreement is Clear

One of the most important aspects of a buy-sell agreement is having clear, concise, and unambiguous language throughout the document. Most importantly, any ambiguity in the contract can be an opening for conflict and potential litigation. If the outlined procedures and company value and assets in the agreement are not clearly defined, assessment of value, structure, and next steps may be at the hands of parties outside of the business owners. Take the time to have an experienced team of attorneys and financial advisors draft and carefully review a buy-sell agreement to avoid conflict and potentially save the business ownership financial hardship.

Provide Funding for the Agreement

If a trigger event ever occurs, the agreement will move the business’s financial assets per the agreement’s language. Part of the agreement must include the source of that money. While using existing assets such as savings, previously agreed-upon payments, loans, financing, or other means, many businesses also turn to life insurance. Depending on the company, life insurance may be the most efficient means to source money upon the departure of a business owner.

Provisions for Repurchase

Buy-sell agreements can also help businesses specify the terms of repurchase. This could include how a repurchase could occur, from what is initially owed, with a balance financed over a period of time, and with what interest rate. Be clear on the terms in the agreement, especially on financing. Interest rates fluctuate over time, and the business owners must review and understand rates and other terms before finalizing the buy-sell agreement.