Things You Need to Know About a Buy-Sell Agreement

Any business owner that forms a business that is co-owned, such as a limited liability company, should draft and execute a Buy-Sell Agreement as soon as it is formed or shortly after. Also known as a Buyout Agreement, this legally binding instrument protects all owners if one of them wishes to leave the business, sell their portion, or passes away. It is crucial towards ensuring that your business will continue to operate smoothly without putting you or your fellow owners at financial risk.

Here are six crucial things to know about a Buy-Sell Agreement and why you should hire us as your business attorneys to prepare one.

A Buy-Sell Agreement does not Involve Buying or Selling the Business

Contrary to what the name suggests, a Buy-Sell Agreement has nothing to do with buying or selling a business. Rather, it is a binding contract between co-owners that establishes when owners can sell their interest, to whom, and at what price. It also comes into effect whenever an owner retires, declares bankruptcy, becomes incapacitated, gets divorced, or passes away. For this reason, a Buy-Sell Agreement is often considered a “prenuptial agreement” between the business owners, since it governs what happens to the departing owner’s interest when they are no longer around.

A Buy-Sell Agreement Can Mitigate the Impact of a Co-Owner’s Bankruptcy

A well written Buy-Sell Agreement will have a provision requiring that any co-owner who faces bankruptcy must inform the other co-owners before filing. This action then becomes an offer to sell the bankrupt owner’s interest to the other owners, with the buyout money going to the bankruptcy trustee. This allows the business to carry on with its operations without being bogged down in bankruptcy court.

A Buy-Sell Agreement May Take Into Account a Co-Owner’s Divorce

Although Florida is not among the states with “community property” laws – which allow an ex-spouse to claim a right to the entire ownership share of their former spouse – the spouse in a divorce settlement can still argue for at least a partial interest in the business, since marital property laws require the equal division of assets during a divorce. With a Buy-Sell Agreement, you can require the former spouse of a divorced owner to sell back any interest they received in the settlement to the remaining co-owners, based on the valuation method detailed in the agreement.

How is the Company Valued During a Buyout?

Although you can hire a professional appraiser to come up with a price based on previous financial statements, the value of the company during the time of the buyout may be different, and each co-owner may utilize a different valuation formula. To reduce conflict, the Buy-Sell Agreement should set forth how the business will be valued in advance, allowing the owners to come to an understanding of a single method.

What if the Other Owners cannot Afford a Buyout?

The solution is simple: rather than require the buyout to be done with an immediate lump-sum payment, the Buy-Sell Agreement should establish flexible payment terms, such as requiring a down payment followed by a series of installment payments over the coming years, with reasonable interest.

A Buy-Sell Agreement Can Help Reduce Estate Taxes

In the case of an intergenerational business, wherein at least one owner plans to transfer their interest to an heir who will be involved in the business, a Buy-Sell Agreement can help reduce the burden of estate taxes by utilizing a conservative valuation formula for the company. This results in a legally lower ownership interest at the time of death, thereby minimizing estate taxes.