What is a Buy-Sell Agreement?
A Buy-Sell Agreement is a contract between members of a jointly owned business (for example the partnership of Joe and Mary in business of Lil’ Shop) that outlines the how, what, why and when a Partner, or member of the company, exits the business.
A Buy-Sell agreement is important for several reasons – firstly, no one knows when a death or traumatic event will occur. Secondly, if one of the business partners die, the business may continue operating with the remaining business Partner with the exiting Partner’s family benefiting from the contribution made by the remaining Partner. This can create tension and additional stress in an already traumatic time for all parties.
Like a business plan that sets out the goals and operational, it is critical to consider these matters ahead of time when all business Partners are operating amicably to ensure that there are documented strategies for the exit of a Partner, whether that be planned or unplanned to ensure a fair outcome for all members of the Partnership. Significant problems can arise in the absence of a Buy-Sell agreement.
For example – Joe and Mary operated Lil’ Shop, which sold party supplies. Joe passed away unexpectedly and his wife, Rose, decided that rather than selling Joe’s share in the business to Mary, that she would take an active role in the business. Rose and Mary did not see eye to eye in the way the business operated and after a year of disagreement their relationship broke down and the business suffered and was sold for well below what it was worth when Joe passed away.
Additionally, it is quite often in the event of a death or retirement of a Partner, the remaining Partner has insufficient funds to purchase the outgoing Partner’s interest and that can result in adverse consequences for all within the business in terms of the business’ ongoing financial sustainability.
What types of issues can be considered in a Buy-Sell Agreement?
A triggering event for a Buy-Sell Agreement can include:
- The death of a Partner (or Director in the case of a company);
- The total and permanent disability of a Partner;
- A trauma;
- The bankruptcy of a Partner;
- The retirement of a Partner;
- A relationship breakdown between the Partners.
Buy-Sell agreements include consideration and documentation of the valuation methodology that the business Partners agree is fair and reasonable in respect of the business being operated, and to be used to determine the value of an exiting Partner’s share upon the occurrence of a trigger event, and dispute mechanism provisions to ensure that the potential for any conflict has been addressed and can be avoided to the greatest possible extent as the valuation methodology has been agreed and documented on a reasonable basis for a business of the kind operated.
A Buy-Sell agreement provides certainty for all parties as what occurs in the event of a trigger event occurring and can include insurance policies that fund the exiting Partner’s buyout whereby the exiting Partner (or their estate) receives the insurance proceeds for the insurable trigger event of the market value of the exiting Partner’s share in the business. Any difference in the market valuation of the exiting Partner’s share is paid by the continuing Partner to the exiting Partner (or their estate) by way of documented terms within the Buy-Sell agreement which usually involves a vendor finance arrangement between the continuing Partner and the exiting Partner.
Additionally, the inclusion of an insurance policy in a Buy-Sell agreement has the benefit of providing certainty for each Business Partner’s personal estate planning.
If you require further information on how a Buy-Sell agreement can assist you, your business Partner and your estate plan, contact Preston Law on 4052 0718.