If you own a part of a business, you should know about buy-sell agreements. Without it, your business faces an unpredictable series of financial and succession issues when any of its owners face drastic events like death, disability, divorce and others.
Here’s a situation that is similar to many that we have seen:
Case Study – Vicky Passes Away with no Agreement in Place
Max and Vicky are about 60 years old and they have been 40-60 shareholders in a successful toy company they started 25 years ago.
Max runs the operations while Vicky runs marketing. Vicky has a heart attack and dies. She has a will that she wrote 20 years ago which gives all her assets to her husband. It was a mirror will that she made with her husband, on the understanding that the survivor would care for their children.
On her death, the shares in the toy company passed to her husband who is an engineer and who has never worked a single day in the toy industry. Max wants to buy those shares and Vicky’s family wants to sell but they cannot agree on the price. Their discussions become heated and ugly.
Without a buy-sell agreement in place, shareholders risk facing such scenarios that can disrupt the business and hurt its value. Furthermore, it can hurt the departing shareholder’s family who may not get fair value for the shares as well as the remaining shareholders who want to keep the company going.
What is a Buy-Sell Agreement?
A buy-sell agreement is a type of shareholder agreement between all or some of the shareholders. It is a legally binding contract that stipulates how a shareholder’s share of a business may be reassigned if that shareholder dies or otherwise leaves the business. Most often, the agreement stipulates that the departing shareholder’s shares are to be sold to the remaining shareholders at a pre-established price.
A buy-sell agreement:
- Is a legally binding agreement between shareholders as to what to do with a
departing shareholder’s shares;
- Specifies that remaining shareholders want to continue the business;
- Specifies that departing shareholder and his family want to be compensated for his share of the business; and
- Is not prohibited by Constitution.
For many business owners, a buy-sell agreement is like the last will and testament for the family’s largest asset perhaps besides the family home. It enables the remaining shareholders to decide who the next shareholder might be and to prevent the possibility of a shareholder selling his shares to unwanted parties.
Buy-sell agreements are quite technically demanding as you can tell from the discussion above. This is because of their flexibility and the countless business situations that are possible. We have thus covered a rather limited series of situations. In reality, the circumstances of each company are unique and buy-sell agreements should have to be customised each time. As a result, it is a good idea to work with a lawyer, accountant and financial planner who are experienced with such agreements rather than rely on agreements that are templatised.