Definition: Buy-Sell Agreements

Buy-Sell Agreements protect a closely-held business from the impact of the unexpected departure of an owner. These agreements can be structured in a way allows the remaining owners to buy out the departing owner’s interest through what is often referred to as Cross Purchase Agreement. Another alternative is to provide for the redemption or purchase of the departing owner’s interest in the business by the business entity itself – in effect, the company buys part of itself back from the departing owner. This type of agreement in a corporate setting is known as a Stock Redemption Agreement.

These two approaches can also be combined. Buy-Sell Agreements can create an initial right to acquire the ownership interest of the departing owner by the entity. If the entity chooses not to do this, the remaining owners are then given an option to purchase the departing owner’s interest. If the shareholders do not purchase all of the departing owner’s interest, the entity is sometimes required to buy the remaining interest.

Buy-sell agreements are typically triggered by one of several events, including (1) a third party offer to purchase; (2) termination of employment; (3) insolvency or the bankruptcy of an owner; (4) the involuntary seizure or transfer of an ownership interest; (5) the disability of an owner; or (6) the death of an owner.

In order to preserve the business and minimize the expense of a buyout, a Buy-Sell Agreement will usually specify how the departing owner’s interest will be valued. To further preserve the business, the terms of the buy-out, including down payment, use of a promissory note and stipulation of an interest rate and the term of the promissory note may also be specified. Finally, in the event of the death of the owner, a Buy-Sell Agreement may be funded through the use of life insurance.

A Buy-Sell Agreement is not a business succession plan. The role of the Buy-Sell Agreement is rather to provide a safety net in order to preserve the business in the event that one of the triggering events occurs. The Buy-Sell Agreement protects the value of the business and allows for the orderly liquidation of a departing owner’s interest with a minimum of disruption to the business of the company.

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