Basics of a Buy-Sell Agreement
A Buy-Sell Agreement, sometimes referred to as a buyout agreement, is a legally binding contract that sets forth compensation and valuation mechanisms based on specified triggering events. Buy-Sells are an effective tool when planning for transfers to third parties and death, disability, divorce, or bankruptcy of an owner. The two most common types of Buy-Sells are the cross-purchase and the redemption. In the former, the remaining owners of the business entity may exercise an option or a right of first refusal to buy out the departing owner’s shares. In the latter, the business entity purchases the departing owner’s shares. Oftentimes, business owners opt for a hybrid of these two, designating certain triggering events where a cross-purchase applies and others where a redemption applies.
How to use a Buy-Sell Agreement to Set Compensation
A key benefit of a Buy-Sell is that it establishes a buyer for an owner’s interest and it predetermines a valuation mechanism for that interest. Three of the most common valuation mechanisms include appraisals, structured negotiations amongst the owners, and formula-based options. Appraisals are often viewed as the least risky option because the determination of value is made by a neutral third party. However, appraisals can be costly and the Buy-Sell should provide direction in the event the seller and the buyer disagree on the appraiser chosen.
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