When you’re enthusiastic about a new business venture, you may not be thinking about a time in the future when your current partnership comes to an end – but you should. The day may come when you want to move on to something new, or your business partner wants to retire, for example.
A buy-sell agreement, also known as a “buyout” agreement, can help plan for this possibility.
A buy-sell agreement is a contract (or a clause woven into a partnership agreement) that can provide a mechanism for a smooth ownership transition in the event of certain future events that could lead to the voluntary or involuntary departure of one of a company’s owners.
What are the key elements of a buy-sell agreement?
The agreement typically involves the business owners, and it can easily be tailored to fit a two-person partnership or a partnership with multiple stakeholders. In general, an effective buy-sell agreement would have the following information:
- A definition of the “triggering events” that put the clause into effect: The agreement should define the specific events that would trigger a buyout, such as an owner’s death, disability, retirement, divorce, bankruptcy or just their written notice of intent to sell their interest voluntarily.
- An agreed-upon business valuation method: The agreement establishes the method for determining the value of the business interest to be bought or sold. Common valuation methods are an asset-based approach, a fair-market value approach and a capitalization of earnings approach.
- How the buyout will be financed: Several funding options could be available, such as cash payments, installment payments, promissory notes, borrowing against company assets or through life insurance policies.
- Restrictions on transfers: The agreement may include provisions that restrict the transfer of ownership interests outside of the existing owners. These provisions help maintain control over who can become an owner and ensure that the remaining partners don’t end up in business with a virtual stranger or someone incompetent.
A buy-sell agreement helps prevent disputes and potential conflicts that may arise during a transition. Having a well-structured buy-sell agreement can also enhance the business’s stability, credibility and attractiveness to potential investors or lenders. Seeking legal guidance can help you make certain that your partnership agreements don’t overlook key features like this one.