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What is a buy-sell agreement and why do I need one? Bryan business lawyers answer

Posted by Chris Peterson | Jul 24, 2012 | 0 Comments

What is a buy-sell agreement and why do I need one? Bryan business lawyers answer

A buy-sell agreement is a contract among business owners regarding how their ownership interests will be disposed of when one dies or leaves the business. The services of a Bryan business attorney are indispensable in drafting or reviewing a proposed buy-sell agreement to ensure it meets the needs of your business and your family.

What happens when no buy-sell agreement is in place?

Imagine two business partners, Joe and Mike, middle aged, happily making decent money, and looking forward to greater prosperity for themselves and their families down the road. Then the unexpected happens: Mike is killed in an auto accident. Let's see how this plays out in the event of Mike's untimely death.

For simplicity, this discussion will be limited to a two-person business. Nevertheless, the same principles apply to, for instance, a limited liability company (an LLC), whose ownership is determined by the number of membership interests, or to a corporation whose interests are defined by shares of stock. Again, a local business lawyer should be consulted in all of these settings.

First, let's assume the partners did not have a buy-sell agreement. And neither was the beneficiary of an insurance policy on the life of the other. Mike's wife inherits his estate. Suddenly, Joe has a new partner: Mike's wife, Mary. Only Mary doesn't know anything about the business and Mike can't stand the woman. You can just imagine the problems this awkward couple might encounter going forward.

If the business owners had an entity purchase agreement

There are two main types of buy-sell agreements. One is known as an entity-purchase agreement in which the parties agree that on the death of one, the business will purchase the deceased partner's share of the business. Partners are free to dictate the terms of such a purchase. They can decide on an all-cash transaction, or one with a down payment and a string of payments over a term of years. As is often said in business, anything is negotiable.   If Joe and Mike and the LLC had an entity purchase agreement, on Mike's death, the LLC would buy out Mike's interest according to the terms of the agreement.  The purchase price would be part of Mike's estate and pass to Mary who would no longer have an interest in the business.

If the business owners had a cross purchase agreement

The other principal type of agreement is known as a cross-purchase agreement in which the partners agree that the survivor will personally purchase the deceased partner's share from the latter's spouse. Again, the terms can be tailored to the parties' satisfaction.

Even more flexibility can be built into such agreements dealing, for instance, with whether the buy-out of the deceased partner's share is mandatory, or at the option of the survivor. In our case, if Mary and Joe had gotten along, and if Mary had been involved in the business, Joe might not have any concerns about Mary's role and, therefore, opt not to buy her out.

Insurance to fund buy-sell agreements

A common feature to both types of agreement is insurance.  Life and disability insurance policies can provide a means to fund the purchase obligations. In the entity-purchase form of agreement, the business purchases policies on each partner. In a cross-purchase set-up, each owner takes out a policy on the other.

Numerous provisions can be built into such agreements, not the least of which is a method or formula for placing a value on the deceased or departing partner's share.

If you operate a small business in Texas, the Bryan business lawyers at the Peterson Law Group can help you put a buy sell agreement in place that will protect your business interests and your heirs. Call us at 979-703-7014 to schedule a consultation or use our online contact form.

About the Author

Chris Peterson

Chris Peterson is the owner of Peterson Law Group. He practices primarily in the areas of wills, trusts and estate planning; probate and trust administration; elder law; and business law. Chris is also the owner of Brazos 1031 Exchange Company.


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