What is a buy and sell agreement?
A purchase and sale agreement is a legally binding contract which stipulates how the share of a business partner can be reallocated if that partner dies or leaves the business. Most often, the purchase and sale agreement stipulates that the available part must be sold to the remaining partners or to the partnership.
The purchase and sale agreement is also called the purchase and sale agreement, buyout agreement, commercial will or business subscription contract.
Operation of a purchase and sale agreement
Purchase and sale agreements are commonly used by sole proprietorships, partnerships and private companies to facilitate ownership transitions when each partner dies, retires or decides to leave the business.
The purchase and sale agreement requires that the share of the business be sold to the business or to other members of the business according to a predetermined formula.
In the event of the death of a partner, the estate must agree to sell.
Understanding purchase and sale agreements
There are two common forms of agreements:
- In a cross-purchase agreement, the remaining owners buy the part of the business that is for sale.
- In a buyout agreement, the business entity purchases the share of the business.
Some partners opt for a mixture of the two, some portions can be purchased by individual partners and the rest purchased by the partnership.
In order to guarantee the availability of funds, the partners of a company generally take out life insurance policies with the other partners. In the event of death, the proceeds of the policy will be used to purchase the business interests of the deceased.
When a sole proprietor dies, a key employee can be designated as a buyer or successor.
Partners must work with a lawyer and a chartered accountant when developing a purchase and sale agreement.
Key considerations in purchase and sale agreements
Buy and sell agreements are designed to help partners manage potentially difficult situations in ways that protect the business and their own personal and family interests.
For example, the agreement may prevent owners from selling their interests to outside investors without the approval of the remaining owners. Similar protection can be provided in the event of the death of a partner.
A typical agreement may stipulate that the interests of a deceased partner must be sold to the remaining business or owners. This prevents the estate from selling the interest to a stranger.
In addition to controlling ownership of the business, purchase and sale agreements define the means to be used to assess value from a partner. This can have uses outside of the issue of buying and selling stocks. For example, if there is a dispute between the owners about the value of the business or the interest of a partner, the valuation methods included in the purchase and sale agreement will be used .
Key points to remember:
Key points to remember
- The purchase and sale agreements stipulate how a partner’s share of a business can be transferred in the event of the partner’s death or departure.
- Purchase and sale agreements can also establish a method for determining the value of a business.
- Cross purchase and sale agreements allow the remaining owners to purchase the interest of a deceased owner or seller.
- Buyback and buyout agreements require the business entity to purchase the interest.