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Utilizing Buy-Sell Agreements to Set Compensation

By:

Michael C. Pallesen, Amanda C. Carter

Submitted by Firm:
Cline Williams Wright Johnson & Oldfather, LLP
Article Type:
Legal Article
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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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