Why Your Small Business Needs a Buy-Sell Agreement

What is a buy-sell agreement?

A buy-sell agreement, much like a will, is a contract that stipulates how members of a corporation can buy out the interests of a deceased or disabled member.

But a buy-sell agreement doesn’t only stipulate next steps in the case of a death or disability. It can also cover what the business should do in the event of a partner’s exit, often due to retirement or divorce.

A buy-sell agreement is most commonly used in sole proprietorships, closed corporations, and partnerships.

Why does your business need a buy-sell agreement?

Without a buy-sell agreement in place, you could face financial, legal, and tax headaches should a member of the corporation leave, die, or become disabled.

For example, without a buy-sell agreement dictating how this matter is to be handled, a deceased business partner’s spouse or children could become part of the management team. These are all decisions you would want to make ahead of time with all business partners or shareholders in agreement.

A buy-sell agreement establishes a fair value price for each partner’s shares.

This expedites the process should a partner want to buy out the shares of an exiting partner. This can potentially help avoid any future IRS disputes.

A buy-sell agreement develops an exit plan.

Don’t want until an emotionally-heightened event, like divorce, occurs to develop an exit strategy for each business partner. By establishing these terms ahead of time, you’ll be able to handle next steps in an exit plan should one partner decide to exit the business.

A buy-sell agreement helps to ensure business continuity.

What will you do should a business partner decide to sell, or face illness or death? This is where a buy-sell agreement comes in to lay out a plan for a company’s continuity.

What are the types of buy-sell agreements?

There are two types of buy-sell agreements commonly used by businesses:

Cross-Purchase Agreement

In a cross-purchase agreement, key members have the opportunity to buy the ownership interest of a deceased or disabled key member. Cross-purchase agreements tend to be used in smaller companies with fewer key members, because they require that each member purchase a life insurance policy on the other members.

Stock-Redemption Agreement

Stock-redemption agreements are formal agreements between all the key members – and the business itself – under which the business agrees to purchase the shares of deceased key employees. Key members agree to sell their shares to the company often in exchange for a cash value in the case of death or disability.