What is a 'Buy and Sell Agreement'?
A buy and sell agreement is a legally binding agreement used to reallocate a share of a business if an owner dies or leaves the business. Also known as a "buy-sell agreement," a "buyout agreement," a "business will" or a "business prenup," buy and sell agreements are used by sole proprietorships, partnerships and closed corporations to divide the business share or interest of a proprietor, partner or shareholder.
BREAKING DOWN 'Buy and Sell Agreement'
In a buy and sell agreement, the owner of the business interest being considered for reallocation must be deceased, disabled, retired or must have expressed interest in selling. The buy and sell agreement requires that the business share is sold to the company or the remaining members of the business according to a predetermined formula. Before the interest of a deceased partner can be sold to the company or remaining partners, the deceased's estate must agree to sell. Without a buy and sell agreement in place, a business can face significant tax burden or other financial difficulties if an owner dies, retires, becomes disabled or otherwise leaves the business.
In order to ensure the availability of funds in the event of a partner's death, most parties will purchase life insurance policies on the other partners. In the event of a death, the proceeds from the life insurance policy are used to purchase a portion of the deceased's business interest. It is important to note that when a sole proprietor dies since there are no business partners, a key employee can be the buyer or successor.
Buy and Sell Agreement: Who Needs Them?
Buy and sell agreements are useful to individuals in a variety of scenarios, such as:
- You want to establish a fair value of a share of a business in case a dispute erupts between owners, such as a case in which one wants to exit and sell out, and another wants to remain and buy out the exiting partner.
- You are a co-owner of a business and want to place restrictions on other owners who may seek to sell their interests to another person or entity that may not have the best interests of the business or remaining partners in mind.
- You want to stipulate that owners or their estates must sell their shares of a business back to the business so the remaining partners can keep control of the company when an owner dies, becomes incapacitated or exits for any other reason.
- You want to stipulate that remaining owners must buy the interests of an exiting or deceased owner to ensure liquidity.