Business Owners – Is Your Buy-Sell Agreement Ready to Go?

October 19, 2021

When owning a business with others, it is very important to have an up-to-date buy-sell agreement in place.  A buy-sell agreement is a legal document that outlines what happens in a business with multiple owners in the event of termination, disability, divorce, or death.  Many business owners admit that they either don’t have such a document in place or if they do, it is outdated.  Absent an effective buy-sell agreement, an unforeseen termination or death of an owner will almost certainly result in management gridlock or costly litigation over the affected owner’s shares.

What is a buy-sell agreement?

A buy-sell agreement is a legal agreement between business co-owners that clearly states how shareholder stock is treated in the event of owner death, divorce, termination, or some other triggering event.  A well-drafted buy-sell agreement eliminates disputes by describing things like what triggering events lead to the disposal of an owner’s shares, whether the other owners will have the opportunity to buy the affected owner’s shares before disposition to an outside party, and how to calculate the value of an affected owner’s shares.

If an owner already knows who he or she wants to transition their shares to, is a buy-sell agreement still needed?

Yes, businesses with more than one owner should always have a buy-sell agreement in place.  These agreements can prevent a stall in business management, as well as ensure proper valuation of a deceased owner’s shares.  Also, a properly drafted buy-sell agreement enables other owners of the business to promptly purchase a deceased owner’s shares according to a pre-determined formula which can prevent the shares in question from being locked up in litigation or potentially in the hands of someone the other owners do not want to be involved in the business.

Once a buy-sell agreement is in place, does it ever need to be updated?

These agreements should be reviewed frequently to ensure they are still functioning in the best interest of both the business and owners.  If a buy-sell agreement is not reviewed regularly, the fair market value of the owners’ shares may not be properly reflected in the document.  If a triggering event occurs, this discrepancy in value could result in lost generational wealth due to an outdated valuation formula.  To determine if an agreement is still effective, the value of the business should be calculated as if a triggering event occurs.  If the business owners are comfortable with the resulting value, the valuation formula should be acceptable to leave in place.

Despite knowing the importance, many businesses do not have a buy-sell agreement in place.  There is time and money involved with getting an agreement completed, but a well-drafted document can save a business from management gridlock and costly litigation in the event of an unforeseen event.