In a perfect world, no one would need a Buy-Sell Agreement; we do not live in a perfect world.
What is a Buy-Sell Agreement?
A Buy-Sell Agreement (sometimes referred to as a Member or Shareholder Agreement) is a contract that spells out the rights and obligations of each partner and the business. The partners can decide what happens if one of them dies or becomes disabled. Do the remaining partners want to continue the business with the deceased partner’s family or do they want the right to buy that interest? Does the deceased partner want to give her family the right to force the company to purchase her interest? What happens when a partner wants to retire, or is disabled and cannot work? These are questions that should be answered in the beginning, while everyone is alive and in a cooperative frame of mind. The creation of the business is also when the agreements will be the most fair, as nobody knows who will die first. Each partner will want a fair agreement to protect herself if she is the purchaser and to protect her family if she is the first to die or want to sell.
Why Do I Need One?
When you started your business, you were able to pick your partners. Without an agreement, you have no control over what happens to their interests. If a partner died tomorrow, his will would dictate who your new business partner would be. If a partner decided to retire, he could choose to sell his interest to anyone he wanted. Furthermore, these agreements are important if the business relationship starts to go downhill. Things usually start out well but disagreements between partners can become heated and difficult to resolve. A divorce from your business partner can be just as difficult and expensive as a divorce from your spouse, and the end-result could be worse – you could find that you lose your business as well. A well-drafted Buy-Sell Agreement will protect each partner in case of a major conflict, as well as in case of a partner’s death or disability, or even a divorce.
Some courts will order the divorcing partner’s share in a business be split between the spouses. A Buy-Sell Agreement can prepare for that possibility by allowing the other partners to buy the shares and prevent the new party from becoming a part-owner.
Who Are the Parties?
All of the owners of the business and the business itself are generally the parties to the Agreement. If the business is going to purchase a retiring or deceased partner’s interest, it is referred to as a “redemption agreement”. If the other partners are going to do the purchasing, this would be considered a “cross purchase agreement”. There are significant tax differences between the two. A plan that may appear to be easier to structure, may have unexpected ramifications on the survivors and the parties being purchased. It is important to discuss all of the implications of the agreement with your legal advisor and accountant to ensure that you have the right type of agreement for your circumstances.
What About Insurance?
Many Buy-Sell Agreements are funded by insurance, so in case of death or disability, there are funds readily available to protect the business and surviving partners and to provide security for the recipients. A good insurance agent should be part of the team working together to create the proper Buy-Sell Agreement for your needs.