A buy-sell agreement is a contractual arrangement between shareholders or partners or the shared business detailing conditions by which ownership interests transfer between the parties in certain events, including death, disability, divorce, financial incapacity, exit from the company, or a management stalemate. A buy-sell agreement recognizes the possibility of future adverse events and prescribes a process agreeable to the respective parties for the continuation or dissolution of the business enterprise.
Negotiation between the various parties, usually with the assistance of an attorney experienced in business and contract law (Federal and State), establishes the agreement’s terms. A buy-sell agreement resolves issues like how, when, to whom, and for what price ownership interests can be sold, thereby protecting the exiting shareholder (liquidity) and the remaining shareholders (control).
The terms of a buy-sell agreement can be simple or exceedingly complex, specifying such details as the valuation method of the asset to be sold, the payment terms (lump sum or serial), or time frames.
Example: BJ Auto Repair Shop
Bill and Joe, brothers-in-law, co-own an automobile repair business. Both are active in the business and split profits 50-50. The company is a significant asset in each man’s net worth and provides each an after-tax income of $150,000. Bill unexpectedly dies, and the business suffers an immediate drop in revenues due to Joe’s inability to pick up the work Bill previously handled. Nevertheless, Bill’s widowed wife relies on the income from the business.
Fortunately, Bill and Joe agreed early in their partnership that the business would purchase a deceased owner’s interest in the company for four times the 5-year-average of a partner’s income. A joint insurance policy purchased by the company provided funds to complete the transaction. Bill’s widow received $700,000 for Bill’s share of the business, and Joe became the single shareholder. He hires a mechanic for less than one-half of what Bill earned as an owner. Without a buy-sell agreement, liquidation of the business might be necessary to provide an income to Bill’s widow.