In our last post, we began looking at the potential usefulness of buy-sell agreements in business succession planning. As we noted, the terms of a buy-sell agreement can vary depending on various factors. Here, we’ll look at several common ways of structuring these agreements.
One of the common arrangements in buy-sell agreements is to negotiate mandatory purchase requirements, which provide for the mandatory sale and purchase of business assets when a triggering event occurs, whether that is disability, retirement, death, a decision to leave the business, or the involuntary transfer of assets to a creditor, as can happen in divorce. Exactly how this works out depends on the terms negotiated, but it ensures the assets end up staying within the business.
Another possibility is to structure the agreement to give a buyer or class of potential buyers an option to purchase the assets in the event of a triggering event. Should the/a buyer choose to exercise the option, the owner would be required under the agreement to sell. Alternatively, a buy-sell agreement can make the transaction dependent on the seller’s decision to sell. If the seller chooses to exercise the option to sell, there would be an obligation to purchase.
Buy-sell agreements also need to address the issue of funding the purchase. Different triggering events may require different methods of funding, depending on the circumstances of the business and the resources of the owners, and there can be various issues to consider with respect to funding, including potential tax considerations.
Because establishing a sound buy-sell agreement is critical to ensuring the smooth transition of a business when one of its owners leaves and for ensuring the business’ long-term success, it is important to carefully plan, negotiate, draft and execute these contracts. Working with an experienced attorney helps ensure things are done correctly. For individual owners, having their own attorney also ensures their interests are protected in negotiating a buy-sell agreement.