What is a buy-sell agreement? A buy-sell agreement, also sometimes called a share redemption agreement, establishes the terms and conditions upon which a shareholder in a professional corporation will be redeemed at certain future events. In the context of a limited liability company, similar provision regarding the liquidation of a member’s interest will often be found in the company’s operating agreement.
For purposes of this discussion, I will be focusing on the corporate shareholder situation. A buy-sell agreement is among the most important documents a business with more than one owner should have. Why? It allows for an orderly transition of ownership and prevents it from winding up in the wrong hands at a likely critical time for the business. A best practice is to establish a buy-sell arrangement as early as possible in a company’s existence. Quite honestly, it is never too early. As the business evolves and grows, the buy-sell can then be revisited and, if necessary, amended to make sure that the “triggering” events of a sale reflect the current state of affairs amongst shareholders and that the valuation method used for establishing the redemption price will yield the expected result. Triggering events often include death, permanent disability, employment termination, retirement or the election to transfer by an existing shareholder. Common valuation methods are by mutual agreement of the parties, or, failing to arrive at such agreement, the use of a prescribed formula or retention of a valuation expert to conduct a business valuation.
In the absence of a properly written buy-sell agreement, the remaining shareholder runs the risk of having the stock pass to a person who does not understand the business or is interested in it. This can lead to unnecessary distraction, dissension and, possibly, even devalue the business. The shareholder being redeemed runs the risk of not receiving the promised value for his or her interest in the business. In short, if you and your business partner do not have a buy-sell agreement currently in place, do yourselves a favor and get one. You will be glad you did.