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Owning a business with someone else — whether it's a family member, friend or professional colleague — can become complicated if one of the owners dies or must leave the business. If plans aren't made well in advance, this situation can lead to a number of challenges. This is where buy-sell agreements may come into play. But, what is a buy-sell agreement, and how do buy-sell agreements work?
Simply put, buy-sell agreements — also known as buyout agreements — are binding contracts between co-owners of a business that spell out what will happen should one of the owners die, become disabled, retire, or leave the business. Understanding how these contracts work can help you decide if this type of agreement is right for your business.
What Is the Purpose of a Buy-Sell Agreement?
A buy-sell agreement can help business owners maintain control over who can partner with them in the future, and it can help to mitigate the possibility of bad feelings added to already difficult circumstances. It can also help to minimize disruptions to the business during a major transition in ownership.
Imagine losing a business partner and finding yourself co-owning with someone you find disagreeable, inexperienced or poor at making decisions. What if your business partner wants to leave the business and demands more money than you think the company is worth? How about seeing part of the business transferred to family members who want to take the profits without doing any of the work?
These agreements can help minimize the possibility of these and other unwanted circumstances, or they can help establish the rules for when they occur. Buy-sell agreements may be used in businesses such as restaurants, medical practices, family farms, start-ups and just about any partnership or business that's directly run by the owners.
How Do Buy-Sell Agreements Work?
A buy-sell agreement could specify who may purchase a departing co-owner's shares of a business and what must happen to trigger such a purchase. It could require partners to buy out the departing co-owner in certain circumstances or allow partners the option to do so before anyone else.
Generally, the contract will spell out the terms of a sale, such as how to determine the purchase price and any limitations on who may purchase part of the company.
This could also include something known as a right of first refusal. For example, the agreement might say company shares could be sold to outsiders only after family members decline to buy. Or, it could include a right of first offer, requiring a co-owner to give the business partners the option of buying the co-owner's share of the company before selling to an outsider.
Co-owners may choose to include other provisions, such as whether a co-owner's family may receive the ownership interest if the co-owner dies. In addition, it can spell out circumstances in which a co-owner must sell back company shares, such as if the co-owner is convicted of a serious crime. This could also involve other triggering events, such as divorce or bankruptcy.
Why Might a Buy-Sell Agreement Be a Good Idea?
Foreseeing possible business complications and charting how to navigate them can make for smoother operation and help to increase the probability that the business will succeed over the long term.
And because a business can change over time, it's also wise to revisit and update your buy and sell agreement periodically to make sure it works for the current business.
If you're contemplating starting or already have a business with someone else, you might consider consulting a financial representative about creating a buy-sell agreement.
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