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Understanding Buy/Sell Agreements

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Perhaps one of the more complex aspects of owning a business, yet one that is frequently overlooked, is succession planning, that is transferring a business to another person after the disability, death or departure of one of the owners. If there is no agreement in place prior to the occurrence of one of these events, the ownership of the business could be subjected to a whole host of personal and legal battles, or the value of the business could be materially impaired. This is why a buy/sell agreement is so important.

Buy/sell agreements establish what will happen to a person's ownership interest in a business after that person has died or has left the business. If you own a fractional interest in a business that generates a substantial amount of revenue, a buy/sell agreement is a necessity.

What is Specified in a Buy/Sell Agreement?

Generally, a buy/sell agreement will address a number of different issues in order to ensure that the departing party's portion of ownership is transferred in the way and at a price that is desired.

Often times, a buy/sell agreement will contain language which prevents a part-owner from selling his or her portion of a company without permission from other part-owners. Other times, the agreement will specify to whom the ownership will be passed after the owner dies or departs from his or her post.

In addition, agreements will typically designate specific times in which it is appropriate for a co-owner to sell his or her portion of the business. They also typically designate a price range at which a portion of the ownership can be sold. They may also provide a methodology for payment of that price over time.

Types of Buy/Sell Agreements

In general, there are three types of buy/sell agreements. These include cross purchase agreements, entity redemption agreements, and hybrid agreements. A brief description of each is contained below.

Cross Purchase

A cross purchase agreement involves remaining co-owners buying the departing co-owner's portion of the company when he or she leaves. In this scenario, no additional co-owners are added into the mix. Each co-owner will simply own more of the company than he or she did in the past.

When a buy/sell agreement of this kind is established, it usually designates a price at which co-owners can buy out the remaining portion. This helps establish a price that is hopefully fair to all parties for the buyout to occur.

Entity Redemption

An entity redemption buy/sell agreement allows for the business itself to buy out the departing co-owner's portion of ownership. An agreement of this type ensures that remaining co-owners will not have to pay for departing owner's interest with money from their individual bank accounts, and may have tax advantages.

Like a cross purchase agreement, an entity redemption agreement will designate a price at which the ownership interest will be purchased. This price could be fixed, or it could be based on a specific formula tied to financial variables of the business. And it can provide affordable payments over time.

Hybrid

The last type of buy/sell agreement we'll discuss is a hybrid of entity redemption and cross purchase agreements. When an agreement of this type is established, it allows for either individual co-owners or the business itself to buy out the departing ownership. Remaining co-owners can decide which option is more beneficial at the time of departure.

Like entity redemption and cross purchase agreements, hybrid agreements generally designate a price at which the departing owners interest is to be bought. Sometimes this price is a hard figure, and other times this price can fluctuate with various other factors.

Need Help Creating a Buy/Sell Agreement in Park Ridge, Illinois?

Do you own a business? Are you interested in creating a buy/sell agreement in Park Ridge, Illinois? If so, the experts here at John J. Pembroke & Associates can help you.

Over our 30 years, our team of business lawyers has helped a variety of business owners to plan and manage their business interests. We would be honored to do the same for you.

Contact us today to schedule an appointment!

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