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Business arrangements are always susceptible to change. Factors that are both internal and external to a business can affect the arrangements between business owners. For example, in the instance where one of your business owners leaves your company, buy-sell agreements can:

  • provide you with greater certainty in terms of your business’ management; and
  • help you avoid disputes concerning finances with your remaining partners.

This article outlines what buy-sell agreements are and explains their key benefits.

What Are Buy-Sell Agreements?

In simple terms, a buy-sell agreement determines what happens with your business partner’s shares in the business if they leave your business. Typically, an option to buy a share in a business will be ‘triggered’ by a specific event outlined in your agreement. For example, a triggering event can include when a business partner retires or passes away, as well as other probable events, including if they:

  • become permanently disabled;
  • become bankrupt; or
  • seek a marital divorce with a co-owner of the business.

In practice, you will often link a buy-sell agreement to an insurance policy held by each business owner. For example, suppose a business partner dies. In that case, a life insurance policy held by the remaining partners might provide the remaining partners with the necessary funds to buy out the deceased owner’s interest. Ultimately, by choosing a suitable life insurance policy that best suits your business arrangement, you can ensure that once a business owner leaves, you can:

  • continue operating your business according to your buy-sell agreement; and 
  • be comforted knowing that the leaving owner is compensated for having their share of the business bought out.

Most importantly, a buy-sell agreement should determine how your business will be valued. Indeed, since the value of your business or its share prices will fluctuate, buy-sell agreements typically provide that valuing of your business will take place at the time the triggering event occurs. However, this is subject to change depending on what you and your business partners negotiate in your buy-sell agreement.

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Certainty in Business Management

A change in co-ownership of your business can upset the balance in any business management. However, an effective buy-sell agreement can provide greater certainty during this period of change.

Essentially, a buy-sell agreement preemptively determines how the remaining owners will manage ownership of the business.

The more detailed your buy-sell agreement is, the more certainty it is likely to provide if ownership changes. Indeed, an effective buy-sell agreement will typically outline:

  • the purpose for entering into the agreement i.e. to ensure that the sale of shares or the transfer of ownership is in accordance with established procedures;
  • any restrictions on the transfer of ownership;
  • notice requirements for the transfer of shares; and
  • the valuation procedure for your business.

Evidently, buy-sell agreements are crucial for the future operation of your business. Therefore, you must draft the agreement carefully and understand its terms in full. In addition, it would be wise to seek legal advice if you are unsure about what your buy-sell agreement means.

Avoiding Potential Disputes in the Future

A dispute between you and your co-owners can easily transpire without a buy-sell agreement, particularly when it concerns finances. At worst, disputes concerning business ownership can result in time-consuming and costly litigation. In the absence of a buy-sell agreement, the following consequences would typically arise. 

Scenario

Consequence

A business owner dies

Without a buy-sell agreement, the owner’s shares in the company would typically pass to their next of kin. 

A business owner files for a divorce

Without a buy-sell agreement, a court may order that the owner’s shares in the company be turned over to their ex-spouse. 

A business owner retires 

Without a buy-sell agreement, an internal dispute can arise concerning who has a priority option to buy the owner’s shares and at what price will the shares be sold. 

To avoid finding yourself in any of the scenarios above, you can ultimately keep your business interest at the forefront of considerations by implementing a buy-sell agreement.

Key Takeaways

A buy-sell agreement can provide your business with great certainty if an owner leaves the business. In essence, an effective buy-sell agreement should detail how:

  • the surviving owners can manage the shareholdings left by the leaving owner;
  • the shareholdings will be valued; and
  • insurance policies will affect the change in ownership and assist the transition.

Ultimately, a buy-sell agreement can help you avoid potential disputes that may arise in the future concerning the management of your business. If you need assistance with drafting a buy-sell agreement for your business, LegalVision’s experienced business lawyers can help. Call us on 1300 544 755 or complete the form on this page.

Frequently Asked Questions

What are redemption agreements?

A redemption agreement is a legally binding contract that allows a business owner to determine the terms by which someone can purchase shares in their business. Business owners typically use redemption agreements to control ownership within their business.

I signed a contract but did not read its terms in full. Does the contract legally bind me?

If you sign a contract, you are bound by it even if you did not read its terms in full. However, there are some exceptions to this general rule, such as if you signed the contract under duress. 

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