A "buy-sell agreement" is an important part of properly establishing your business entity in order to limit liability in your business structure.
In fact, state statutes governing the statutory close corporation actually mandate that the owners enter into a buy-sell agreement. Moreover, sound business planning dictates that a buy-sell agreement also be used in a limited liability company (LLC) or conventional corporation, especially when there are two or more owners.
The buy-sell agreement prevents an owner from selling his interests to an outsider without the consent of the other owners. The agreement usually takes one of three forms:
- Cross-Purchase Agreement. In this form, a withdrawing owner agrees to sell his interest to the remaining owners. This is the simplest form of the buy-sell agreement. It is suitable especially for the small business with only a few owners. As the number of owners increase, this form can become unwieldy. In a larger business, an entity-purchase agreement may be more suitable.
- Entity-Purchase Agreement. In this form of the buy-sell agreement, the withdrawing owner agrees to sell his interest to the entity, which then retires the ownership interest.
- Hybrid Agreement. This form is a combination of the first two. Typically, the withdrawing owner must first offer his ownership interest to the entity. If the entity declines or is unable to make the purchase, then the shares must be offered to the other owners.
Ownership certificates must be endorsed with notice of the restriction on transfer created by the buy-sell agreement. In many cases, state statutes require that precise language be used in the ownership certificates. Thus, it is important to examine the particular state's statute and incorporate the exact required language into all ownership certificates.
A proper buy-sell agreement not only describes how an interest will be sold, but for how much as well. The agreement spells out how interests will be valued when they are sold, so as to avoid these kinds of disagreements.
Moreover, events may arise that could necessitate the selling of an ownership interest. Specifically, what if an owner goes bankrupt or is forced to liquidate or, worse yet, dies or becomes incapacitated? Insurance policies are often bought by owners to cover these circumstances.