Why a Buy-Sell Agreement Is Important for Your Business

Posted:  Dec 15, 2022

Any business partnership where two or more people share ownership, including LLCs, shareholders in a corporation, and partners in a partnership, should have a buy-sell agreement. This legally binding contract outlines what happens when an owner dies or wants to leave the business and can help to prevent disagreements between the remaining owners. 


Without a buy-sell agreement, the death of one owner can cause financial hardship for the others, as they may be forced to sell their shares to pay the deceased owner's estate. A buy-sell agreement can also provide liquidity for owners who want to retire or leave the business for other reasons. Setting up a predetermined buyer and price ensures that the departing owner will receive fair value for their shares. In short, a buy-sell agreement is an essential tool for any business partnership.


Benefits of a Buy-Sell Agreement

1.     Establishing a Fair Value Price for Shares

This type of agreement can help establish a Fair Value Price for Shares, as it provides a clear process for setting a price and ensures that all parties are aware of the agreed-upon price in advance. This can prevent disputes and confusion, making it easier to transition ownership if needed. In addition, a buy-sell agreement can help to protect the interests of minority shareholders by ensuring that they receive a fair price for their shares.


2.     Develop an Exit Plan for Partners

The breakup of any partnership can be complicated. Partners may only agree on a split when the terms are clearly stated. A buy-sell agreement will spell out the specific terms and conditions that partners must abide by if one partner is no longer with the company.


3.     Keep Business Interests With Surviving Owners

Not having an agreement in place means running the risk of having to welcome unwanted or unexpected business partners. A buy-sell agreement will specify who gets a share of a business when one partner can no longer be a part of it or intends to sell their share. If there's yet to be an agreement, a partner's next of kin might take over part of the company. This could lead to significant disruption or possibly even the dissolution of the company should an heir decide to sell.


4.     Create a Business Continuity Plan

A buy-sell agreement helps to ensure that the business can continue operating even in the event of an unforeseen event. By spelling out what will happen in the event of an owner's death or disability, a buy-sell agreement helps to create a business continuity plan that can keep the business running smoothly even in tough times. In addition, a buy-sell agreement can help resolve disagreements between owners about how the business should be run, ensuring everyone is on the same page and avoiding costly litigation.


How to Set Up a Buy-Sell Agreement

Ensure to work with a Steven and Company Law Corporation corporate attorney to help craft an effective buy-sell agreement that covers all of the basic ground. Below are the five areas you need to cover.


·       Begin Early

As a business owner, you know that your company is only as strong as its weakest link. That's why it's so important to have a buy-sell agreement in place from the beginning. The process will be far less combative or emotional when you take care of these details before any business occurs. Without a buy-sell agreement, the ownership of your company could become chaotic and disruptive, potentially leading to its downfall.


·       Create Ground Rules

Creating ground rules for how the buy-sell agreement will be structured is important. The first step is to agree on a valuation method. This can be done by hiring an independent appraiser, using a formula based on earnings or revenue, or agreeing on a set price. Once the valuation method is agreed upon, the next step is to choose a trigger event that will activate the agreement. This could be the death or disability of an owner, retirement, or even someone's desire to sell their share of the business. Once these ground rules are in place, creating a fair and reasonable buy-sell agreement that meets everyone's needs will be much easier.


·       Take Out Life Insurance Policies

One way to fund a buy-sell agreement is to take out life insurance policies on the owners. The death benefits from the policies can be used to buy out the deceased owner's share of the business, ensuring that the family can continue to run the business and maintain their income. 


·       Include a Valuation Clause

A valuation clause is an essential component of any buy-sell agreement. This clause defines the value of the business and establishes a clear price for the buy-sell transaction. It will also help determine how to calculate the value of a partner's stake in the company if they are no longer involved.


Without a valuation clause, the parties to the agreement may have different ideas about the value of the business, which could lead to conflict and litigation. A well-drafted valuation clause should consider all relevant factors, including the company's assets, liabilities, and earnings potential.


·       Pay Attention to Taxes

When drafting a buy-sell agreement, paying attention to tax implications is important. For example, if the business is structured as an S corporation, the sale of shares may trigger a taxable event for the shareholders. Similarly, if the business is held in a trust, the sale of assets may be subject to estate taxes. Ensure you have a simple and conservative valuation formula within your agreement to free yourself from unnecessary taxes as part of a sale.


Call Us Today to Schedule a Consultation With a Steven and Company Law Corporation

Without a buy-sell agreement, your company is vulnerable to several potential disasters. If you have any questions about putting such an agreement in place for your business, or if you need help drafting or negotiating the terms of a buy-sell agreement, don't hesitate to get in touch with the corporate lawyers at Steven and Company Law Corporation. We would be happy to help you protect your interests and ensure that your business is prepared for the future.




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