As Robert W. Wood put it in his article in Forbes, “If you own all or part of a business—any business—you should know about buy-sell agreements.” And, given the vast majority of all U.S. businesses are family owned or controlled, there are many business owners out there who need to know about these agreements, as do their attorneys. For those of us not yet up on them, here’s a primer on buy-sell agreements.
The purpose of a buy-sell agreement is to provide for an orderly transition of ownership interests when certain specified events occur, e.g., an owner wants to sell his or her interest in the business, or an owner dies, becomes disabled, or retires. The point of a buy-sell agreement is to keep the business running smoothly when an owner desires or is forced to sell his or her interest in the entity.
Typically, a buy-sell agreement controls the circumstances under which an owner may sell his or her interest, who is a permitted buyer, and how the price paid will be determined.
Among the many benefits of having a buy-sell agreement, are that they:
- Allow the remaining owners to determine with whom they will work and share control of the entity;
- Prevent outsiders or heirs, whose interests may conflict with those of the entity or the remaining owners, from obtaining an ownership interest;
- Ensure continuity of management and control by the remaining owners;
- Increase job stability for minority owners and key nonowner employees;
- Provide for the orderly liquidation of the owners’ interests in the event of death, disability, retirement, or other forced or voluntary withdrawal;
- Prevent the continued involvement in the business of retired or inactive owners;
- Create a market for the shares of deceased, retiring, or withdrawing owners;
- Generate cash to pay death taxes and estate settlement costs;
- Fix the value of the interest for estate and gift tax purposes; and
- Prevent the loss of an S corporation election by preventing a transfer of the interest to an ineligible shareholder (e.g., a corporation).
You can draft a buy-sell agreement as either a stand-alone agreement or incorporate it into the business’s operating agreement (e.g., as covenants within a shareholder agreement or as part of a partnership agreement). If you go with the second route, be very careful to make sure that the operating agreement and the terms of the buy-sell agreement don’t create a conflict.
Buy-sell agreements are governed by basic contract law and drafting principles. So, keep all those basic rules in mind as you draft it. If the buy-sell agreement doesn’t reflect adequately or accurately a transaction or describe and protect the client’s rights, it fails in one of its essential purposes and may result in either a dispute on an ambiguous or incomplete contractual provision or a malpractice claim based on an inadequate buy-sell agreement that worked to the client’s disadvantage.
For everything you need to know about buy-sell agreements, including a checklist of agreement provisions, turn to CEB’s Business Buy-Sell Agreements. On use of buy-sell agreement in estate planning, turn to CEB’s Business Succession Planning: Strategies for California Estate Planners and Business Attorneys, chap 6.
CEB also has a great program Buy-Sell Agreements for California Businesses, available On Demand.
To brush up on California law on drafting contracts in general, see Drafting Business Contracts: Principles, Techniques & Forms, and on principles of contract law, see California Law of Contracts.
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