Also called Buyout Agreements, Buy / Sell Agreements are wonderful devices designed to help reduce risk for businesses and business owners. They provide a plan in the event a business owner is no longer in a position to continue his or her ownership of the business.
When an owner of a business wants to leave, retire, or passes away, there are often issues regarding ownership of the business. A Buy/ Sell Agreement is often adopted as part of the Operating Agreement or Bylaws, helping resolve these issues. It spells out what events trigger the Buy / Sell Agreement, the price of the available shares, and who can purchase the shares, among numerous other important decisions. Often a Buy / Sell Agreement is insured by a life insurance policy on the owner’s life, which is triggered if an owner dies. This guarantees the other owners have the money to buy the exiting owner’s shares.
As an example, Pluto and Lassie, two young entrepreneurs and beer enthusiasts, are co-owners of a successful beer company. After a couple of years their company, Dog Beer, is worth $1 million. If Lassie passes away, lots of questions arise. Is Pluto now co-owners with Lassie’s wife who knows nothing about the beer business? Does Pluto have an option to buy Lassie’s shares, and if so does that mean Pluto has to pay Lassie’s wife $500,000 for those shares? Will Lassie’s family sell the shares to an investor Pluto has never met? Will Dog Beer simply go out of business, leaving both Pluto and Lassie’s families in financial ruin?
These and many other questions can be prevented by having a good Operating Agreement and Buy / Sell Agreement in place.
There are a number of options when it comes to Buy / Sell Agreements. Cross-Purchase Agreements, Redemption Agreements, and Buy/ Sell Agreements funded by insurance are just a few of the available options.
- A Cross-Purchase Agreement provides the other owners the option to personally buy the shares of the exiting owner.
- A Redemption Agreement ensures that the business itself buys the exiting member’s shares.
- When an insurance policy is put in place, it means each of the owners has a life insurance policy taken out on them. If an owner dies, then there is cash available to pay the decedent’s family for those shares.
When it comes to running a business, it is crucial to think about ways to protect your business and provide security for your family. Make sure you talk to a professional about Buy/ Sell Agreements and what options are available to you. As we tell many of our clients, spend the time necessary to draft a good Operating Agreement and make Buy/ Sell Agreements part of the conversation.
John I. Henderson practices corporate and business law in Charleston, South Carolina. He focuses on transactional work and litigation. John particularly enjoys working with startups and helping small businesses.
