A buy-sell agreement is an agreement among the owners of a business that if any one of them leaves the business, then they will sell their ownership interest to the remaining members or to the company itself. This type of agreement can be used with any type of business structure.
Hw buy-sell agreements work
A buy-sell agreement is designed to help ensure that the ownership of a company will continue to be held by the surviving owners if one of them passes away, retires, or becomes disabled. All of the members agree that—should this happen to them—they will sell their ownership interest to the other members or back to the company.
The agreement establishes a price for the ownership interest. Often the company pays for a life insurance or disability policy that has the company as the beneficiary, allowing it to purchase the departing member's ownership share with the proceeds. A buy-sell agreement can be set up for a partnership, LLC, or corporation with shares.
Why buy-sell agreements are important
When you form a business with someone—whether as partners, LLC members, or a corporation—you're investing time and money into a joint venture. As business owners, you are loyal to each other and to the business.
Now, imagine one of your partners passes away. His ownership interest becomes part of his estate. His will may leave everything to his wife. Now, suddenly, you're partners with her, and the success of your business rests upon working with her. A buy-sell agreement helps prevent this scenario from happening.
These types of agreements help ensure stable ownership of the company, keeping the rest of the owners in charge if something happens to one owner.
The buy-sell sets a value on the ownership interests so that, if one person dies or needs to sell, there is a price in place. The buy-sell is good for the remaining members because of this, but it is also good for the exiting member because the agreement helps ensure the liquidity of the ownership interest and requires the members or company to buy back the exiting member's share.
One-way buy-sell agreements
Buy-sell agreements make a lot of sense for companies with more than one owner. However, if you are the sole owner of your business, this type of agreement doesn't work for you.
As a sole owner, you could lose the value you've built up in the company if you decide to retire or if you become disabled. If you pass away, your family is left trying to run the business or sell it. And your valuable employees face the loss of their jobs and incomes, once you no longer own the business.
A solution is a one-way buy-sell agreement. In this type of agreement, you find a buyer for your business and agree that the buyer will have right of first refusal on the sale of the business.
The sale will become available when a specific event occurs: your death, your becoming disabled, or your retirement. Usually the assets of the business are used to pay the debts of the business and the buyer then is purchasing the remaining value.
The buyer often pays for a life insurance or disability policy on the life of the business owner, with the policy proceeds payable to the buyer. If the owner dies or becomes disabled, the policy pays the buyer, who uses the life insurance funds to pay for the purchase of the business.