The buy-sell agreement is one of the most important elements of a partnership agreement, shareholder agreement or operating agreement. The buy-sell agreement is in place to safeguard against changes in circumstance that occur from a change in control of the company, dissociation or expulsion of a partner, shareholder or member, death, incapacity, resignation, etc., of one of the business owners.
The buy-sell agreement addresses questions that may arise from such changes in circumstances, such as:
- How would a decedent’s heirs liquidate the ownership interest in order to pay expenses and taxes?
- What happens if an heir or outside buyer of the decedent’s share in the business interferes with the operation of the business?
- Can the business buy back the decedent’s ownership interest?
- How is a member, shareholder, or partner’s economic interest to be bought our in the event of expulsion or dissociation;
- How is a business owner to be bought out in a judicial dissociation or dissolution;
- How is a valuation to be determined for each partners, shareholders, or members economic interest in the company should a change in control of the company occur?
Buy-sell agreements are meant to address potential problems that may arise after a business organization by specifying the terms of the value of an economic interest is determined in the event of change in control, dissociation, expulsion, death, divorce, disability, or retirement. The buy-sell agreement is necessary in situations where a partnership, corporation or limited liability company seeks financing, loans, or leases. The buy-sell agreement generally will show lenders, purchasers or other third party that the business is stable, well organized, and has provisions in place accounting for possible future changes in circumstances.
There are two main structures for buy-sell agreements: (1) cross purchase agreements, where the remaining owners of a business buy the other partner’s, member’s or shareholder’s economic and business interest; (2) redemption agreements, where the company buy’s (or redeems) the other partner’s, member’s or shareholder’s economic and business interest. Life insurance policies are typically used to ensure that funds are available for cross-purchase and redemption transactions.