A smooth transition of business ownership will be important to every entrepreneur at some time in the future. The Buy-Sell Agreement is for a specific instance of departure strategy. 

It’s a contract between and among business owners that creates a mechanism for the acquisition of ownership interests once an owner leaves due to a triggering event (i.e., death, divorce, disability, retirement, etc.).

It’s not difficult to set together a good buy-sell agreement, fortunately. We answer the “who, what, when, where, and why” issues that occur in a normal buy-sell agreement. 

This arrangement is also known as a shareholder agreement or a succession agreement. We’ll go over what a buy-sell agreement is, how it helps company owners, and what’s the importance of a buy sell agreement.

What is a buy-sell agreement?

A buy-sell agreement is a contract that allows you to sell your business stake or acquire a co-interest owner’s in the company in the future. Business continuation agreements and buyout agreements are other names for buy-sell agreements.

The owners of a firm engage in a contract for the transfer of an owner’s stake in the business upon the occurrence of a defined “triggering event” under the provisions of a buy-sell agreement. Death, disability, and retirement are all common triggering events. An efficient buy-sell agreement includes the following clauses:

• Whether the other owners or the business have the chance to purchase that owner’s interest before it is sold to a third party.
• When and under what conditions might a firm sell an owner’s interest?
• Who are the surviving owners ready to accept as a replacement owner?
• How much should that interest be charged?

The following are the two most prevalent forms of buy-sell agreements:

• Cross-Purchase Agreements: Contracts in which the remaining owners purchase the interests of the departing owners.
• Entity-Purchase Agreements: Contracts in which the corporation buys out the interests of departing shareholders.

What is the Importance of a Buy-Sell Agreement?

A buy-sell agreement’s main goal is to keep ownership and operations within the existing management/ownership group, avoid interference from the exiting owner’s family, provide liquidity to pay estate taxes/retirement, avoid succession and value disputes with the exiting owner’s family, and ensure a smooth transition to the next generation.

After deciding on the sort of buy-sell agreement, the following step is to decide on the valuation technique that will be used in the agreement. While there are a number of different value processes to select from, the following three are the most commonly used:

Fixed Price Agreement 

By specifying a value for the company’s stock, the price of future acquisitions is set at a certain dollar amount.

Benefits: 

All owners agree on a price and are aware of the buy-sell price.

Disadvantages: 

1. Due to the ongoing evolution of a firm, the fixed price becomes obsolete; 

2. Owners seldom know the true worth of a business and establish unrealistic prices

3. Different triggering events may result in different values (i.e., death of an owner, retirement of an owner, removal of an owner, etc.).

Formula Agreement

Provide a particular formula based on a multiple of the company’s operations to establish value.

Advantages: 

Once the formula is chosen, the particular calculations required to calculate the buy-sell price are known.

Disadvantages: 

1. No formula used at a given moment may produce appropriate and realistic values throughout time 

2. the value of the interest may be unreasonable depending on the timing of the triggering event.

Business Valuation Agreement

Describes the procedure for pricing future deals (i.e., they define the valuation process). These agreements stipulate that one or more business appraisers be used to determine the price at which future transactions will take place. report on the valuation of a company

Advantages: 

1. Provide a defined structure or process for determining the price at which future transactions will occur

2. All parties agree on the process

3. Instead of determining the value themselves, owners obtain a qualified independent expert opinion

4. Attorneys are familiar with the business valuation process.

Disadvantages 

1. The price isn’t set yet

2. It may get expensive

3. Anxiety about the process’s end value might be unpleasant

4. Owner uncertainty about what will happen if a triggering event happens.

Based on the foregoing, owners should strongly consider using a business valuation as the proper valuation technique inside a buy-sell agreement. 

It is strongly suggested that legal counsel be retained to assist in the process of selling a business due to the complexity and necessity of selecting the proper form of buy-sell agreement and valuation method.

When unanticipated occurrences occur, a buy-sell agreement ensures a smooth transition of a business. Let’s see how.

Consider a situation in which two women own a firm together. Unexpectedly, one of the owners passes away. 

A few months after the co-death, owner’s the dead owner’s husband visits the surviving owner and informs her that his wife’s half of the business has transferred to him, and he inquires as to why he has not gotten his late wife’s share of the earnings since her death.

He then requests copies of the company’s financial records, implying that the remaining owner may be overpaying himself. If the surviving owner and the husband are unable to reach an agreement, the problem will very certainly have to be settled in court.

The surviving owner may have avoided such an expensive dilemma if the co-owners had a buy-sell agreement in place. A buy-sell agreement might be a standalone document, or it can be integrated into a shareholders agreement or an LLC operating agreement.

Aside from a partner’s death, buy-sell agreements can cover a variety of eventualities, including a partner’s handicap, retirement, a company partner who fails or refuses to satisfy his or her commitments, or a business partner who develops a drug or alcohol addiction. 

Any of these problems might act as “trigger events,” forcing one owner to sell to the other. The next stage is to describe a system for determining the price of the interest being acquired once the trigger events have been stated in the agreement.

There are a few alternatives available. The price can be determined using a formula that the owners agree on. Alternatively, the owners might meet once a year (or more frequently if they like) to agree on the business’s valuation, generally in collaboration with their CPA. 

That value would then be documented in a “Certificate of Agreed Value,” which would bind the owners for a set length of time, generally a year. 

If a trigger event happens in the following year, the certificate’s value will be set at the purchase price of the seller’s interest in the firm.

The buy-sell agreement might also provide that the firm will retain a business appraiser to establish the worth of the leaving owner’s interest if a trigger event occurs.

The payment of the purchase price is usually addressed in the buy-sell agreement. Requiring the purchase price to be paid in full at the closure of the buy and sale would most likely be a huge strain on the firm and the remaining owner. 

Rather, the buy-sell agreement will provide payment conditions that are not excessively burdensome.

Buy-sell agreements can be used to determine the fair market value of a company’s stock, design exit strategies for business partners, maintain the company’s interests with the surviving owners, and construct a business continuity plan.

Buy-sell agreements are vital instruments for small and medium-sized firms to ensure orderly transitions, and it is critical that these agreements be in place at the moment of establishment.

The owner will have to go to court to address these concerns if no agreement is reached. 

A lawsuit over a firm’s ownership or the value of an owner’s business stake may be a lengthy and costly procedure, and it may result in a judge’s judgement that is not in the best interests of the surviving owner or the business itself.

It is definitely worth the legal fees to put in place a detailed buy-sell agreement from the start of the firm to avoid future complications and the considerably greater costs that come with them.

For this, eSahayak can help. You don’t need to start fresh or engage an attorney to create your Buy-Sell Agreement. You may easily generate your Buy-Sell Agreement in 5- 10 minutes using eSahayak. Simply click here, fill a form, and eSahayak will generate a Buy-Sell Agreement based on your responses.