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What protections does a buy-sell agreement provide?

On Behalf of | Aug 9, 2021 | Uncategorized |

Starting a business on solid ground includes a combination of hard work, marketing research and investment resources, as well as a plan for future growth and expansion. It is important for the savvy business owner to also protect the company from financial risk in case the unexpected happens, such as if a partner or shareholder leaves the company, falls ill or passes away.

Many important documents go into entity formation for businesses that are not sole proprietorships. The inclusion of a well-written buy-sell agreement will keep the business stabilized in the event that a partner or owner departs. For New York City business owners, having effective legal counsel to represent their interests when drawing up contracts and other vital documents will ensure the business is on the right track from the outset.

What are the ingredients of a good buy-sell agreement?

A buy-sell agreement, also called a buyout, is a contract made between shareholders that limits their actions in the sale or transfer of shares if they leave the company. It does not cover the purchase or sale of the company. Limiting the actions of the departing shareholder safeguards the company and other shareholders from facing the complications and instability that could result if the shareholder leaves.

Some contingencies that a good buyout agreement should contain are:

  • whether or not the company will buy out the departing shareholder
  • if so, who may buy out the shareholder’s stock
  • the valuation of the shareholder’s interest
  • the payout terms

The agreement not only clarifies in writing how the shareholder may dispose of their ownership interest in the company, but also provides protections from the risk of an unwanted buyer obtaining an interest.

The agreement should also identify what events would trigger a buyout of a shareholder, including the shareholder’s:

  • termination of employment
  • personal bankruptcy
  • divorce
  • disability
  • retirement or death

How does the company finance the buyout?

Included in the buy-sell agreement should be the means by which the company will finance the buyout. Buyouts are commonly funded through life insurance policies, or by a direct payment of the transaction with a portion of the company’s assets, with repayment of the balance back with income earned over time.

Buy-sell agreements can be stand-alone documents, but are more often part of the business articles of confederation or bylaws.