A buy-sell agreement is a contract between co-owners/founders of a company that dictates the mechanics of buying and selling a departing co-owner/founder’s interest in the company. A buy-sell agreement is often compared to a marital prenuptial agreement because it addresses, in advance, how a co-owner may depart from the business and what happens to his/her shares upon departure. As a practical matter, a buy-sell agreement becomes crucial when a co-owner dies, becomes disabled, divorces, faces bankruptcy, etc. because it controls what can be done with the co-owner’s shares. To that extent, a customized buy-sell agreement is crucial for businesses with more than one owner or founder, and can prevent litigation related to a co-owner’s departure later on down the road.
Generally speaking, there are three different ways that a departing co-owner’s interest may be purchased: (1) the business itself may purchase the interest of the departing co-owner/founder; (2) the remaining owner(s) of the business may purchase the interest of the departing co-owner/founder; and (3) the business and the remaining owner(s) may, in conjunction, purchase the interest of the departing co-owner/founder. Various considerations may guide a business in deciding which route to pursue, and which terms to include in a buy-sell agreement. Factors include, but are not limited to:
- How the business will fund the purchase of a departing co-owner or co-founder’s interest, including source of funds and nature of payments (i.e., lump sum payment versus down payment followed by subsequent installment payments);
- Tax implications based on type of business entity and purchase structure under the buy-sell agreement;
- Who is included as a party to the buy-sell agreement; and
- How the business will value the shares of the departing co-owner/founder, including whether the valuation is dictated by the buy-sell agreement, an agreed-upon formula, or a third-party appraisal.
A buy-sell agreement should be in place on the very first day the business is formed or shortly thereafter to reduce the financial risk for the company and its co-owners/founders. While businesses can find template forms online, forms are not always appropriate. They are not tailored to reflect the particular circumstances of the business, including considerations such as present state of the business and growth potential; or the full discussions between the co-owners/founders. On that basis, even if a business feels absolutely confident about the types of terms it would like to include in a standard buy-sell agreement, it is imperative to consult with a business attorney and an accountant regarding legal and tax ramifications of the agreement, respectively. At the very least, an attorney and accountant can review a draft of a buy-sell agreement and provide co-owners/founders with some peace of mind that the contemplated draft is appropriate for their specific business needs.
Smith Shapourian & Mignano, LLP is available to answer any questions or concerns you may have regarding your company’s buy-sell agreement, as well as to litigate any disputes arising from a buy-sell agreement. Please contact us for a consultation.
This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.