A buy-sell agreement is an agreement between the owners of a business to purchase and sell interests of the business at a pre-determined price upon the occurrence of anticipated or potential future events. These triggering events generally include death, disability, bankruptcy, divorce, retirement, an offer to purchase, and termination of employment of one of the owners. The buy-sell agreement can be drafted as a stand-alone agreement or can be incorporated in the entity’s operating agreement (e.g., as covenants within a shareholder agreement or as part of a partnership agreement). An imprecise or badly drafted buy-sell agreement may result in either a dispute regarding an ambiguous or incomplete contractual provision.
In general, there are three types of buy-sell agreements:
- Cross-purchase agreement. This may also be referred to as a shareholders’ or partners’ agreement, which requires, or gives an option to, the remaining owners to purchase the ownership interest of a withdrawing or deceased owner.
- Redemption agreement. This is also called an “entity purchase agreement,” under which the entity is obligated – or has an option – to purchase the ownership interest of the withdrawing or deceased owner.
- Combination agreement. Under this arrangement (also sometimes known as a “wait-and-see” clause), the entity has either an option or an obligation to purchase the ownership interest of the withdrawing or deceased owner, but to the extent the ownership interest is not purchased by the entity because of legal restrictions, lack of sufficient funds, etc., the option passes to the other individual owners.
Continuity of the business among multiple parties is typically the primary goal in pursuing a buy-sell agreements. Through them, business owners can provide for the smooth transition of management and operations in a manner acceptable to all the owners, key employees, investors, and lenders. A carefully crafted buy-sell agreement permits the owner to plan for the transfer of control and ownership to the next generation within his or her family without fear of losing control over the business before he or she is ready.
It also may allow the owners to preserve the legal status of the business (i.e. S corporation, professional corporation). Other goals include preventing outsiders, whose interests may conflict with those of the entity or the remaining owners, from obtaining an ownership interest; providing for orderly liquidation; and providing for favorable capital gains treatment of a departing owner.