What is a buy-sell agreement?
Contrary to popular belief, a buy-sell agreement is not about buying and selling companies; rather, it is a binding contract between business partners. A buy-sell agreement is made up of several clauses in your written partnership agreement (or it can be a separate agreement that stands on its own) that control the following business decisions:
- who can buy a departing partner’s share of the business (this may include outsiders or be limited to other partners)
- what events will trigger a buyout (see the list below), and
- what price will be paid for a partner’s interest in the partnership.
It may help to think of a buy-sell agreement as a sort of “premarital agreement” between you and your co-owners.
What events should you cover under a buy-sell agreement?
Your buy-sell agreement will instruct and remind you and your partners how you have agreed to handle the sale or buyback of an ownership interest when one partner’s circumstances change. Typically, the events that trigger a buyout of a partner’s interest under a buy-sell agreement are:
- an attractive offer from an outsider to purchase a partner’s interest in the company
- a divorce settlement in which a partner’s ex-spouse stands to receive an ownership interest in the company
- the foreclosure of a debt secured by an ownership interest
- the personal bankruptcy of a partner, or
- the disability, death or incapacity of a partner.
For fill-in-the-blank buyout clauses and instructions on how to incorporate them into your partnership agreement, see Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence (Nolo.com).
If you don’t create a buy-sell agreement
When starting a new business, you may think that the last thing you have time for is worrying about what will happen when you or another owner wants out — or worse, dies. But it’s a huge mistake to ignore the fact that sooner or later your business will change. If you doubt this even for a minute, think about what would happen if you don’t create a buy-sell agreement and one of the following occurs:
- One partner quits to move to another city or leaves to start another business. Without an agreement, your partnership might, by law, be dissolved, forcing you to divide any assets and profits among the partners and decide whether to start a new partnership with the remaining partners. Even if your partnership doesn’t end, you will still have to decide whether you should buy out the departing partner’s ownership interest, and for how much.
- One partner dies, gets divorced or becomes mentally or physically incapacitated. In this case, you might have to work with the spouse or other family member of a deceased, disabled or divorced owner. There is a substantial possibility that the family member would be inexperienced or otherwise unable to act in the best interests of the business. On the flip side, you (or your family) might get stuck with a small business interest that no outsider wants to buy and for which no insider will give you a decent price.
- One partner sells his or her share to a stranger or to someone you know well and can’t stand. In this case, you may be forced to share control of the company with an inexperienced or untrustworthy stranger — or you’ll be faced with the struggle of running a business with someone you’d rather not even see on the street.
Just looking at this list, it should be obvious that if you don’t anticipate and plan for circumstances like these, you’re risking serious personal and business discord — perhaps even court battles and the loss of your business.