What Is a Buy and Sell Agreement?

What Is a Buy and Sell Agreement?

Let me explain what a buy and sell agreement is—it's a legally binding contract that dictates how a partner's share in a business gets reassigned if that partner dies or leaves for any other reason. Typically, this agreement requires that the share be sold to the remaining partners or the partnership itself. You'll often see these agreements funded by life insurance policies to cover buyouts in case of death.

You might hear it called a buyout agreement, a business will, or even a business prenup.

Key Takeaways

These agreements lay out exactly how a partner's business share transfers upon their death or exit. They can also set a method for valuing the business. The main types are cross-purchase and entity-purchase, sometimes combined. In cross-purchase, remaining owners buy the deceased or selling owner's interests. In redemption agreements, the business entity buys those interests.

How a Buy and Sell Agreement Works

You see buy and sell agreements commonly in partnerships and closed corporations to ease ownership changes when a partner dies, retires, or exits. They keep outsiders from taking control and help value each owner's stake.

The agreement mandates that a departing or deceased partner's share be sold to the company or remaining members based on a set formula. To pay for this, partners often take out life insurance on each other, with the company covering it as a business expense and partners as beneficiaries.

If a partner dies, the insurance payout goes to the survivors, who use it to buy the shares from the estate, keeping the business running smoothly without fights over control or probate involvement.

These agreements aren't just for partnerships—you can use them in LLCs, corporations, or even sole proprietorships, where you'd name an employee as the buyer or successor.

Important Note for Sole Proprietors

When a sole proprietor dies, you can designate a key employee as the buyer or successor in the agreement.

Types of Buy-Sell Agreements

There are two primary types: in a cross-purchase agreement, the remaining owners or partners buy the share that's up for sale. In an entity-purchase agreement, also called a redemption agreement, the business itself buys the deceased's share.

Some choose a hybrid, where parts are bought by individual partners and the rest by the partnership. A wait-and-see agreement mixes elements, deciding at the time of need whether it becomes cross-purchase or entity-purchase based on what's best for continuity.

Tip for Crafting Agreements

You should work with an attorney, a certified public accountant, and a life insurance professional when putting together a buy and sell agreement.

What Is Included in a Buy-Sell Agreement?

These agreements vary by business needs and state laws, but generally, they cover a list of involved partners or owners and their equity stakes, a recent business valuation to price each interest, events that trigger a buyout like death, disability, bankruptcy, or retirement, who buys what, how the buyout is funded—often through insurance—and tax and estate planning for partners and beneficiaries.

Advantages of Buy-Sell Agreements

These agreements help you manage tough situations to protect the business and personal interests. For instance, they can restrict selling interests to outsiders without approval from remaining owners. In death cases, they ensure the interest goes back to the business or owners, stopping the estate from selling to strangers.

They also define how to value a partner's share, which helps beyond buyouts—like resolving disputes over company value.

Buy-Sell Agreement Templates

You can find low-cost or free templates online for drafting these agreements, which work well for new or small companies. But as your business grows or if you have many partners, get a lawyer to draft it properly.

How Do You Establish a Buy and Sell Agreement?

This is a contract that outlines how remaining partners or owners get the shares of someone who dies or leaves, usually with help from a knowledgeable attorney. To ensure funding, partners buy life insurance on each other, and proceeds fund the purchase upon death—handle this through an experienced life insurance agent.

What Are the Disadvantages of a Buy-Sell Agreement?

Drawbacks include limiting owners from selling to anyone not in the agreement, which might have been fine initially but could change. The set purchase price might become outdated, too high or low for current conditions. Plus, having a lawyer draft it can be costly.

What Is the Benefit of a Buy and Sell Agreement?

It ensures smooth ownership transitions and business continuity when a partner or major owner leaves. This legally binding contract sets how shares are acquired by remaining partners, avoiding legal fights. Without it, shares might go to a spouse who keeps or sells them, and partners might lack funds to buy.

The Bottom Line

Business continuity matters, especially with multiple partners or key equity holders. A buy and sell agreement provides a clear plan for distributing shares of a departed or deceased partner to the others, often funded by life insurance for deaths.