A buy-sell agreement is often referred to as a ‘business will’. It allows the parties to the agreement to set out how their interests in the business will be dealt with upon a trigger event including death or total and permanent disability (TPD). A buy-sell agreement can be used by both a partnership and a company and can be used in conjunction with a partnership agreement or shareholders’ agreement or incorporated into these documents.
What is a Buy-Sell Agreement?
A buy-sell agreement is, in a general sense, an agreement between co-owners of a business that grant:
- An outgoing proprietor the option to sell its respective interest in the business to a continuing proprietor(s) (known as a put/sell option); and
- An option for a continuing proprietor(s) to purchase the outgoing proprietor’s interest in the business (known as a call/buy option), upon the occurrence of specified trigger events.
These trigger events are generally involuntary events such as death and TPD and can also include critical illness and trauma.
Why Have a Buy-Sell Agreement?
A Buy–Sell Agreement provides some key benefits to a business and is an integral part of the business succession planning process. Some key benefits include:
- minimising the uncertainty for the business operation;
- reducing the risk of ownership disputes upon a trigger event;
- providing the outgoing proprietor or its estate financial compensation for the disposal of its interest in the business;
- allowing the business’ continuing proprietor to acquire the outgoing proprietor’s interest in the business upon a trigger event; and
- providing the continuing proprietor with financial protection by allowing him or her to concentrate on dealing with the impact on the business in the absence of an outgoing proprietor. Rather than how are they going to buy the outgoing proprietor’s share in the business or prevent a third party from doing so.
How are Buy-sell Agreements Funded?
A buy-sell agreement deals with the funding of the buy-sell obligations of the respective proprietors. Insurance is considered the most common and effective form of funding. The business’ proprietors generally take out insurance policies for the relevant trigger events. The sum insured is the value of each owner’s share of the business, updated at least on a yearly basis. Here, when a trigger event takes place, the remaining business’ proprietors will apply for a payout of the outgoing proprietor’s insurance policy to pay for their purchase of the outgoing proprietor’s business interest.
A business proprietor can own an insurance policy in a number of ways including:
- company ownership;
- superfund trustee; and
- insurance trusts.
What Else is Included in a Buy-Sell Agreement?
Besides granting the necessary buy/sell options for the proprietors, buy-sell agreements may also make provision for:
- The exercise period for any option;
- The calculation of the value of the interest and company value including requirements for independent valuations. As the business will likely change over time, the agreed value is usually the value at the time of the trigger event;
- Consequences for the exercise of an option;
- The transfer of the interest including assumption of liabilities, release by proprietors and indemnity;
- Termination and adjustment;
- Representations and warranties; and
- General provisions.
If you need a business lawyer with experience in drafting contracts to assist you with your own buy-sell agreement, LegalVision’s team would be delighted to assist. Please get in touch on 1300 544 755.