If you are a partner, or shareholder of a closely held corporation, you may have been asked to execute a buy-sell agreement by some of the other partners or shareholders. Understanding what a buy-sell agreement is, and how it is used, can help you decide whether or not to enter into the agreement.
A buy-sell agreement is a common tool used for the purposes of succession planning for small to medium sized businesses. In essence, a buy-sell agreement simply pre-arranges the sale of each partner’s or shareholder’s interest in the business in the event of incapacity or death.
A buy-sell agreement can achieve two important goals if drafted properly. First, it can ensure continuity of the business in the event of the unexpected death or incapacity of a partner or shareholder. Second, it can ensure the partner or shareholder that he or she will receive the fair market value of his or her interest in the business in the event of incapacity or death.
The precise terms of a buy-sell agreement can vary widely; however, in most cases the purchase price is determined at the time of execution of the agreement. In the alternative, a mechanism for establishing the fair market value of your interest is included in the agreement. In addition, specific triggering events are listed in the agreement, such as death or incapacity. If one of these events comes to pass, the agreement is activated. The other partners or shareholders are then legally bound by the terms of the agreement and, therefore, must buy out your interest in the business. The profits can then be used to care for you in the event of incapacity or will become part of your estate in the event of your death.
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