Preface: The cost of a buy/sell agreement is miniscule compared to preventing the turmoil that can result among family members or owners when capital or equity interests are traded. Buy/sell agreements, plain and simple, make sense no matter your business. If you have a corporation, LLC or partnership – any business with more than one equity holder – you need a buy/sell agreement.
Why You Need a Buy/Sell Agreement for Your Business
Any business that has more than one equity holder needs a buy/sell agreement. A buy/sell agreement is a written contract that specifies the steps that will be taken if an equity holder wants to release his ownership. The documented rules in a buy/sell agreement determine how values will be appraised and payment made during fragile business conditions. In addition, a buy/sell agreement can prevent other partners from selling to other individuals or competitors, such as anyone joint equity holders do not want to hold equity. Buy/sell agreements specify rules for a business entity or other owners to acquire another equity interests in specific in the event of an owner selling for retirement, death, disagreements, defaults, or incapacitation. So you could say a buy/sell agreement is a “business will,” and prevents unfair treatment of all equity holders in delicate situations arising from the trade of of a business interest.
A buy/sell agreement is typically a legal document prepared with attorney oversight. The document contains a prearranged agreement for a sale of business interests. The agreement is not limited to 1) who can purchase a departing partner’s or shareholder’s equity interests, 2) the methodology or hybrid appraisal for determining value, or 3) events that will spark a buy/sell agreement.
In a corporation, a buy/sell may result in treasury shares, and necessitate terms for the trade value between the shareholder and the corporation. The cost of a buy/sell agreement is low compared to preventing the turmoil that can result among family members or owners when capital or equity interests are sold. Buy/sell agreements, plain and simple, make sense no matter your business. If you have a corporation, LLC or partnership, any business with more than one equity holder, you need a buy/sell agreement.
What do you need to know to talk your attorney and hold an intelligent conversation? First, you can have a redemption buy/sell agreement where your interest is traded to the business, so the other owners don’t need to pay out of their own checking account. Or, you can have a cross-purchase agreement where another equity holder has first right to purchase your interest. A cross-purchase agreement allows partners or shareholders to acquire your interest, or you to buy other equity interests.
Second, and more important, the nucleus of a buy/sell agreement ensures proper valuation of a business when there is an unanticipated pending sale of an interest. Valuation is key to a fair market sales price of an interest. Valuation of your business should occur every several years with a buy/sell agreement to ensure you have a documented benchmark history of the business value from say the basement to the peak.
At a minimum, you should value your business at the writing of a buy/sell agreement, as well as every time the buy/sell is updated. Your buy/sell should also should list specifically the method(s) the appraiser will use to calculate the business value in the marketplace, e.g. the income approach or say a market approach. Typically the most successful buy/sell valuations carefully avoid unnecessary hybrids, e.g. complex combinations of income, asset or market approaches.
In summary, A buy/sell agreement is a written document prepared with attorney oversight, that details the requirements and play rules for trades of a business interest in instances of ownership change. If you own a business interest with partners or shareholders, you need a buy/sell agreement. If you already have a buy/sell agreement, make sure it is updated when necessary. If you do not yet have a buy/sell agreement for your business, talk to your trusted advisor or CPA about obtaining one today.