Buy-Sell Agreement

The contract between co-owners of a business that says what happens to an owner's share when they die, leave, divorce or go bankrupt - who must or may buy it, at what price, and with what money.

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What it means

A buy-sell agreement is a pre-arranged answer to the question every closely held business eventually faces: what happens to an owner's interest when the owner is no longer there. It names the triggering events - death, disability, retirement, termination of employment, divorce, personal bankruptcy, an attempt to sell to an outsider - and for each one says whether the company or the other owners must buy the interest, may buy it, or have a right of first refusal, and whether the departing owner or their estate must sell. It may be a standalone contract or a set of provisions inside an operating agreement or shareholders' agreement.

The price mechanism is where these agreements succeed or fail. Common approaches are a fixed price the owners agree to update periodically and usually forget to, a formula tied to earnings or book value, or an appraisal by one or more valuers at the time of the trigger. Payment may be a lump sum or instalments over a term, and death triggers are often funded with life insurance the company or the other owners hold on each owner. A recent Supreme Court decision confirmed that life insurance proceeds a corporation receives to fund such a redemption count toward the corporation's value for federal estate tax purposes, which changed the arithmetic of the insurance-funded structure for many family businesses.

A well-drafted agreement also carries drag-along and tag-along rights for a sale of the whole company, restrictions on transferring interests to outsiders, and sometimes a shotgun clause under which one owner names a price and the other chooses whether to buy or sell at it. Without an agreement, the default is the state's entity statute: an heir or an ex-spouse may become a co-owner, and a departing owner may be able to force a dissolution or be stuck holding an interest no one is obliged to buy.

Where this comes from

When people hire a lawyer for this

Co-owners without an agreement should have one drafted while they are still on good terms, because the document is far harder to negotiate once a trigger is in sight. Owners who already have one should have it re-read when the business changes materially in value, when an owner marries or divorces, and when insurance funding is in place, since the estate tax treatment of that funding has recently shifted.

Worried about the cost? A lawyer can be hired for one part of a case only (limited-scope representation), may be paid from what a claim recovers (contingency fee), or may be free through a pro bono programme or legal aid; a court can also waive its own filing fees.

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Related terms

Other entries in the same area of law, each written from the same primary sources.

• Asset Purchase vs Stock PurchaseThe two ways to buy a business - buying what it owns or buying the entity that owns it - and why the choice decides which liabilities come with it, which contracts transfer, and how the price is taxed.
• Breach of ContractA failure to do what a binding agreement required - and the question a court actually asks is not whether someone broke a promise but what the loss was and whether it could have been avoided.
• DBA (Fictitious Business Name)A registered trade name under which a person or company does business - which tells the public who is behind the name and does nothing else.
• Fiduciary Duties and the Business Judgment RuleThe duties of care and loyalty that directors, officers, managers and controlling owners owe the business, the rule that protects honest decisions that turned out badly, and the derivative suit that enforces them.
• Franchise Disclosure Document (FDD)The document a franchisor must give a prospective franchisee before any contract is signed or money changes hands - what the federal rule requires it to contain, what it does not promise, and the state laws that add registration and relationship rights.
• General and Limited PartnershipsA general partnership can be formed by conduct with no paperwork and makes every partner personally liable; a limited partnership requires a filing and shields the partners who do not manage. What each is, and the LLP and LLLP variants.
• Indemnification and Hold Harmless ClausesThe contract provision under which one party agrees to cover another's losses and defend it against claims - what it usually reaches, the state laws that void some of it, and why insurance is the other half of the promise.
• Independent Contractor vs EmployeeTwo legal categories of worker with very different consequences for taxes, overtime and liability - and a label in a contract does not settle which one applies.
• Letter of Intent (LOI) and Term SheetThe preliminary document that sets out the main terms of a deal before the contract is drafted - which parts of it are usually binding, which are not, and how a "non-binding" letter still creates obligations.
• Limited Liability Company (LLC)A business form that shields its owners from most business debts while staying simpler to run than a corporation.
• Non-Compete AgreementA promise not to work for a competitor or start a competing business for a period after a relationship ends - enforceable in some states, sharply limited in others, and void in a few.
• Non-Disclosure Agreement (NDA)A contract restricting what one or both sides may do with information the other shares - and, unlike trade secret law, it binds only the person who signed it.
• Operating AgreementThe private contract among an LLC's owners that decides who controls the company, how money is split, and what happens when someone leaves - or the state's default rules decide it for them.
• Personal GuaranteeA promise by an individual - usually a business owner - to pay a company's debt personally if the company does not, which puts the owner's own assets behind the loan or lease regardless of the entity's liability shield.
• Piercing the Corporate VeilThe exception under which a court holds an owner personally liable for a company's debts, despite the limited liability the company normally provides.
• Registered AgentThe person or company a business entity must designate to receive lawsuits and official notices on its behalf - and the address at which a default judgment can quietly begin.
• S Corporation ElectionA tax election, not a kind of company - what electing S status does to how a corporation or LLC is taxed, who is eligible to make it, and how it is lost.
• UCC Financing Statement (UCC-1)The public notice a lender files to stake its claim on a borrower's equipment, inventory, receivables or other business property - the filing that decides who gets paid first when a business fails.

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