Buy-Sell Agreement Definition

What is a buy-sell agreement?

A buy-sell agreement is a contract between two or more parties that gives the other parties the right to buy out the other’s interest. Commonly, business owners use buy-sell agreements to give the other partners an opportunity to buy the shares first. This helps encourage internal ownership of the company before bringing in a new partner. 

How are buy-sell agreements used?

The parties typically enter into a buy-sell agreement long before the agreement may come into play. Often, they sign this agreement when they start the business or when someone joins the company. 

Buy-sell agreements are a useful way for business members to maintain and control the current ownership of the business. For example, let’s say that four friends start a corporation together, and each has a 25% ownership interest in the company. A year later, one of the friends decides to leave the business and wants to sell their shares. With a buy-sell agreement, the remaining members of the corporation have the option to buy the departing member’s shares. 

What are common buy-sell agreement terms?

Now that we know what a buy-sell agreement is, let’s go over common provisions of buy-sell agreements, meaning what these agreements usually contain. The parties have flexibility as far as what they put in the agreement, but some commonly used provisions include:

• Who can sell the shares under the agreement
• What event(s) trigger the buy-sell agreement
• How much the seller may sell the shares for
• How to calculate the fair value of the shares
• Who can purchase the shares under the buy-sell agreement

Close corporations have a vested interest in making sure that they can maintain their close corporation status. Because of this, these companies may place additional restrictions on who can buy the shares, for how much, and how much total ownership any one shareholder can have. 

What events might trigger a buy-sell agreement?

Events that may trigger a buy-sell agreement include:

• Death of a member
• Departure of a member
• Incapacitation of a member
• Involuntary departure of a member

The parties have the flexibility to decide what events they would like to trigger the agreement. 

Buy-Sell Agreement Benefits

Here are some buy-sell agreement advantages:

• Allows parties to keep current ownership 
• Limits the chance that outside parties will join if a partner leaves
• Gives partners predictability in terms of what will happen if another partner leaves

It can be hard to know what a good price will be for the shares in the future. One of the buy-sell agreement disadvantages is that what seemed like a fair value of the shares at the time is no longer the case. To counter this, parties can use a formulaic approach to determine the value of the shares. For example, they can say that parties can purchase the shares for the fair market value at the time of the triggering event or the purchased value, whichever is greater. 

Summary

Buy-sell agreements are a contract between two or more shareholders in a business. Under the contract, certain parties can purchase a departing member’s shares in a company at a specified price. 

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