Why Every Business Needs a Buy-Sell Agreement

Relevant For:

Business owners, partners, co-owners and successors.

Key Points:

  • Protect against the ‘Seven Ds’: Death, Disability, Divorce, Default, Departure, Disagreement, and Deadlock.
  • Buy-Sell Agreements ensure fair transitions during unexpected events.
  • Agreements provide first purchase rights to ‘continuing’ owners and ensure outgoing owners can sell their share.
  • Address four core issues: trigger events, outcomes, valuation, and funding.
  • Include valuation mechanisms, family provisions, and non-compete clauses.
  • Insurance can fund buy-outs with tax considerations.
  • Proactive agreements prevent random events from causing business failures.

Full Article:

Being in business with a partner offers numerous advantages: companionship, shared risk, complementary skills, and greater resources. However, it is crucial to protect yourself against unexpected events, known as the ‘Seven Ds’:

  1. Death;
  2. Disability;
  3. Divorce;
  4. Default;
  5. Departure;
  6. Disagreement; and
  7. Deadlock.

These events can be both personal setbacks and significant commercial challenges.

When one of these events occurs, one business owner may wish to take full control, while the other owner or their family might need funds to sustain their lifestyle. This situation raises critical questions:

At what price can one owner buy out the other, and how will this buy-out be funded?

Planning Ahead

Many diligent business owners, their staff, and clients suffer due to a lack of preparation for the Seven Ds. From the outset, it’s wise to consider how to ensure a fair and final transition for owners if one of these events occurs.

Establishing a Buy-Sell Agreement early, while all parties are on equal footing, is essential. This agreement outlines how an owner’s exit will be managed and funded.

Understanding Buy-Sell Agreements

A Buy-Sell Agreement, or buy-out agreement, governs the exit of owners from a business. It applies regardless of the business structure, whether a unit trust, company, partnership, or other. These agreements are typically between the business entity and individual owners. The primary purpose is to:

  • Grant ‘continuing’ owners the first option to purchase the outgoing owner’s share.
  • Ensure ‘outgoing’ owners can have their share purchased by the business entity or the remaining co-owners.

Well-drafted agreements anticipate key issues and are tailored to the business's needs, stakeholders, and industry.

Core Elements of a Buy-Sell Agreement

A comprehensive Buy-Sell Agreement addresses four critical issues:

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