Buy and Sell Agreements
What is a buy and sell agreement?
A buy and sell agreement, or buy-sell agreement, is essentially a legally binding contract that outlines what will happen to a co-owner or partner’s share of a business in the event that he/she dies or becomes incapacitated. Having a buy and sell agreement will ensure that a business has a clear plan to handle any of these events.
How a buy and sell agreement works
Buy and sell agreements are most commonly used by sole proprietorships, partnerships, close corporations and private companies. They are put in place to protect a company’s longevity and to provide for smooth transitions of ownership in the event that a co-owner or partner dies, becomes incapacitated or decides to retire. Generally, a buy and sell agreement will require that a co-owner or partners shares be sold to the company or the remaining members of the business.
There are two common forms of buy and sell agreements:
Cross-purchase agreement: In this type of agreement, the remaining shareholders are permitted to purchase the shares of the co-owner or partner in question.
Redemption agreement: In a redemption agreement, the business entity will purchase the shares of the co-owner or partner in question.
In order to ensure that there are funds available to make these purchases, it is common practice for business partners to take out life insurance policies against one another, and in the event of a death of one of the partners, the proceeds from the policy are be used to purchase the deceased’s business interest.
The need for a buy and sell agreement
Buy and sell agreements are extremely important, especially if there is more than one business owner. Any company, no matter the size, can use a buy and sell agreement. A sole proprietor may also need a buy and sell agreement. For example, in the case where a business owner wants a loyal employee to take over the company in the event of his/her death or retirement, this could be arranged through a buy and sell agreement. Under normal circumstances, agreements are drawn up when a business is created, however, they can be drawn up at any time.
There are a number of scenarios that could occur if you do not have a buy and sell agreement in place. For example, in the case where a business partner dies, his/her shares would normally pass to their next of kin. This means that a former business partner’s spouse could land up with a large number of shares in the business and may choose to sell them off to a third party or attempt to run the company in a way that wouldn’t be in the best interests of the shareholders. You wouldn’t want to land up with a business partner or shareholder who doesn’t necessarily know how the business should be run..
If you are looking to set up a buy and sell agreement, contact Affinity Wealth today and we can guide you through the process.