Why You Need a Business Buyout Agreement

A business buy-sell agreement – sometimes called a buyout or partner buyout agreement – is vital to any small business that has more than one owner.  And that includes family businesses.

But the terminology is tricky. This is not about buying and selling businesses. Rather, it is an agreement between partners or co-owners governing these basic things:

1)         When – and under what conditions – a partner or co-owner can sell his or her interest in the business.

2)         Who will be allowed to buy into the business.

3)         Circumstances that would require a co-owner to sell.

4)         How the price of an owner’s interest will be determined.

Think of it as a kind of pre-nuptial agreement for biz owners. There are too many uncertainties to leave this to chance, including death, divorce, retirement, bankruptcy, misconduct and just plain disinterest in the business that can happen over time.

But while the causes are many, the results are predictable. Without this agreement, an owner’s exit can be rancorous and disruptive, perhaps at a time when the business can least afford the headache. There are loads of what-ifs:

What if a partner gets divorced and her ex-husband —who gained part ownership in the settlement — causes trouble?

What if a co-owner demands to be bought out at an unreasonable price?

What if an owner develops a substance abuse problem, goes bankrupt and your new co-owner is one of his creditors?

Yet get the idea. The process of working out a buy-sell agreement can even strengthen a business from the outset, as partners better understand the possibilities…and each other.

Be sure to think about funding. Just because an agreement calls for a partner buyout doesn’t mean the money will be available. “Key person” life and disability insurance can help. Or the agreement might allow installments over a period of years.

Your agreement should include a right of first refusal that prevents departing partners from selling without first offering their interest to remaining owners. This is one way to control who is allowed to own an interest in the company. It will prevent unwanted outsiders from buying in, and allows the business to buy a deceased owner’s interest rather than allow inheritors to move in.

The topic of ownership vs. employment is also touchy. For example, what if an active partner wants to stop working day-to-day in the business, but still wants to remain an owner? Is this allowed? Your buy-sell agreement can address this issue.

While setting a price on the shares can be exceedingly difficult, you can certainly include a formula for setting the price as part of the agreement.

There are three basic buyout agreement types:

1)         In a “cross-purchase” agreement, a departing owner sells directly to remaining owners. This works best for partnerships, LLCs or S-corporations with no more than a half-dozen or so owners.

2)         In “Stock redemption” or “entity-purchase” agreements, the business itself buys back the departing owner’s interest and retires the shares. Thus, each remaining owner’s interest becomes more valuable.

3)         “Hybrid” agreements combine elements of both.

Once you have an agreement in place, review it regularly. Circumstances will undoubtedly change, and your agreement must change too. Pay special attention to the valuation formula. Have the business appraised every few years as a crosscheck.

These resources can help:

  • Business Owner’s Toolkit is a helpful website with advice and information on buy-sell agreements that is both succinct and authoritative. Enter “buy-sell agreements” in the site search tool to find what you need. Visit www.toolkit.cch.com.
  • Nolo, the self-help legal solutions publisher, has several articles and a handy buy-sell agreement FAQ you can access for free. Nolo also sells an excellent plain-English guide to writing your own buy-sell agreement. Business Buyout Agreements, 5th edition ($45 print; $35 eBook only), that comes with worksheets and sample agreements on a CD.
  • The detailed FAQ on buy sell agreements at FindLaw.com is also a good resource.
  • Buy-SellAgreements.com sells a fully customizable buy sell agreement template that you can download for $30.
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Filed Under: BasicsFamily BizFeaturedLegalOwners Only


About the Author: Daniel Kehrer, Founder and Chief Content Officer of BizBest Media, is a senior-level leader in digital media, content development and online marketing with special expertise in startups, SMB, social media and generating traffic, engagement and leads. He holds an MBA from UCLA/Anderson and is a passionate entrepreneur (started 4 businesses), syndicated columnist, blogger, thought leader and author of 7 business and financial books.

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