Why you need a buy-sell agreement

Buy-sell agreements are typically used to ensure the smooth continuity of a business after a disruptive event. Such events include:

• Death
• Disability
• Divorce
• Retirement
• Voluntary transfer of the business
• Criminal conviction
• Loss of professional licence
• Termination of employment either by resignation or dismissal

Buy-sell agreements provide a clear transition of ownership if one of the disruptive events occurs.

Why are buy-sell agreements important?

Ensuring business continuity is essential, particularly if you have multiple partners or equity holders who are involved in the day to day running of the business. A buy-sell agreement provides a legally binding contractual plan for how to distribute shares of deceased or otherwise departed partners to those who remain. They are most commonly used in partnerships, sole proprietorship, and closed corporations.

How are buy-sell agreements structured?

Buy-sell agreements can be drafted in such a way as to meet the individual needs of a business and its owners. The two main structures are:

• Entity-purchase agreements mandate the business to buy the departing or deceased partner’s interests
• Cross-purchase agreements oblige each partner to agree to buy a share of the deceased or departing partner’s interest

The following are also possible but less common:

• Unilateral or one-way agreements are used when there is only one partner and they are selling their interest, typically to another family member or employee (although not always)
• Wait and see agreements are used when the partners are uncertain whether the business or they themselves will buy the interest

Buy-sell agreements can be drafted to combine any of the above structures.

Does your business need a buy-sell agreement?

Knowing when to have a buy-sell agreement can be difficult, but it is always beneficial to have one just in case. Benefits to having one include:

You can establish a fair value price for shares

Buy-sell agreements determine the value of an individual’s shares in a business. This is particularly important if one partner wishes to remain in the business after another’s departure. The agreement helps dispel potential disagreements surrounding the fairness of a buyout offer because it sets out the figures in advance. You can also reduce the risk that a former partner or their family expect more money than their share is, in reality, worth.

Development of an exit plan

The disintegration of a business partnership can be messy and complicated. It can be extremely difficult for former partners to agree on the terms of separation, particularly in cases where this hasn’t been recorded in writing. A buy-sell agreement sets out terms and conditions business partners must comply with if they are no longer part of the company. By planning ahead, you will reduce the financial risk.

Keeps business interests with the remaining owners

Without a buy-sell agreement, you risk unexpected business partners becoming part of the mix. This happens if a former partner’s next of kin takes over their part of the business. Additionally, other partners are left vulnerable to significant disruption. It also opens up the possibility of company dissolution if the beneficiaries of a deceased partner’s estate decide to sell.

A buy-sell agreement sets out who is entitled to your share of the business if you can no longer be a part of it. Or, if you want to sell.

Creates a business continuity plan

Any unexpected event has the potential to disrupt your business. Death, illness, or even divorce could cause business chaos without a contingency or continuity plan. But by creating one, you can safeguard your business against, if not every eventuality, but many obstacles such challenges cause. You will know who is responsible for what, and how the nuts and bolts of the business will continue despite prevailing circumstances.

Minimises emotional impact

Developing a buy-sell agreement before it is required has the real potential to minimise emotions when making big decisions. This is because partners are focussed on the agreement as opposed to their own interests.

Life Insurance

Most business owners and partners take out life insurance policies against each other when they enter a buy-sell agreement. This ensures that the other partners have the financial liquidity and access to funding to buy out the deceased owner if the worst happens. Proper funding provides a financial resource to ensure the basic functions of the business can continue to be carried out.

Do buy-sell agreements last for a long time?

Longer term, it is not sufficient to simply create a buy-sell agreement and then leave it. You have to ensure it remains realistic and practical in light of any changes to the business. Therefore, it is important to review the provisions contained in your agreement periodically. You should make sure all contingencies related to your business remain suitable since the last review. Additionally, you should check whether the business’s valuation needs to be updated.