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Why a Buy-Sell Agreement is Essential for a Small Business

Whether you’re starting a new business or are fully engaged in running one, it’s vital to plan ahead for what happens to the enterprise when you or one of your co-owners retires, becomes disabled or passes away. Creating an agreement that provides for such contingencies can help you ensure a smooth transition that avoids business disruption and spares you significant expense and anxiety.

A buy-sell agreement provides clear directions on how one owner’s stake in the company can be purchased, whether by an existing co-owner or by an outside party. It can provide an exit plan for owners who decide they no longer want to be involved in the company. The agreement can restrict who can buy into the business and how. Typically, the agreement contains a right of first refusal, which gives the remaining owners the option to buy the interest of a departing owner before that interest can be sold to someone from the outside.

A buy-sell agreement can spell out how control and ownership rights are transferred when specific defined events trigger the activation of its provisions. These events may include an owner’s:

  • Death
  • Disability
  • Divorce
  • Termination by the company for misconduct, fraud or other cause
  • Bankruptcy
  • Commission of a crime

A buy-sell agreement can also detail how the company should be valued at the time a triggering event occurs. The valuation affects how much the remaining owners have to pay to the departing owner or to surviving family members in the event of an owner’s death. Choosing an appropriate method is especially important for a small business, whose value may be largely comprised of intangibles such as customer good will and brand association. The buy-sell agreement can also specify how the remaining owners must pay the departing owner — such as by cash, a combination of cash and stock or an installment plan — and how the company can fund the buyout, such as through insurance policies or loans.

By deciding these things ahead of time, the buy-sell agreement reduces the potential for conflict and expensive litigation. However, once you have a buy-sell agreement in place, don’t just place it in a drawer and forget about it. Be sure to review it every year and make any changes necessary. For example, the valuation method you chose when the agreement was written may no longer be the best one for the company in its current condition.

The business and corporate law attorneys of Hayes, Berry, White & Vanzant, LLP draft and review buy-sell agreements for clients throughout North Texas. To arrange a consultation, call 940-230-2386 or contact us online. We have offices in Denton, Flower Mound, Gainesville and Celina for your convenience.

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