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Understanding the Components of a Buy-Sell Agreement

You want to protect your company against disruptive, harmful, and nonproductive owners, which may include divorced spouses, competitors, and disgruntled former employees. And you’re also thinking that your estate needs protection. You decide to enter into a buy-sell agreement while the interests of the parties—your partners and yourself—are aligned or at least not sufficiently misaligned that it would be impossible to discuss the business and valuation aspects of these agreements.

You know that when a trigger event occurs, the interests of the parties—buyers and sellers—may diverge and agreement over pricing and terms can become difficult or impossible to achieve. The following list includes features you should examine when devising your own agreement:

  1. Agree before trigger events and other dissension occurs. You need to agree on possible future occurrences so that the agreement can be written, signed, and dated in advance of these events.
  2. Identify which future events need to be considered. Many things can happen that may trigger the usefulness of a buy-sell agreement: owners may quit, be fired, retire, pass away, become divorced, or go bankrupt. Decide which future potential triggers you want to include in the buy-sell agreement. It’s important that all owners think seriously about these issues. If the buy-sell agreement operates satisfactorily, it will kick in when an applicable event occurs.
  3. Define the trigger events. Firings can be with or without cause, so agreements need to specify what happens in each circumstance. You and your partners should try to anticipate what could happen and document the occurrence in the agreement.
  4. Determine the price at which the identified triggers will occur. This is one of the hardest parts of establishing an effective buy-sell agreement. It’s also why many appraisers and other advisers recommend appraisal with a predetermined appraiser as a generally preferred pricing mechanism. These buy-sell agreements have fixed prices and they are ticking time bombs because they’re seldom updated.
  5. Determine the terms under which the price will be paid. In this regard, important factors to consider include down payment, payment schedule, interest-rate schedule, and fixed or floating interest rate.

Buy-sell agreements are based on different business situations and are formed by unique parties—you and your partners. For more on the components of buy-sell agreements and how they can work for your firm, give us a call today.