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CEA Legal | Buy-Sell Agreements: How they work, Key Provisions

In closely-held businesses, a few unfortunate prospective events need to be addressed from the outset to be prepared when and if they occur.  What happens in the event of death, disability, retirement, or termination of one of the partners? At Cea Legal, our role as business attorneys is to share with our clients the automatic consequences of certain events unless dealt with in writing at the time of starting up the business and plan for an orderly transition. “In the unlikely case that your partner passes away, do you want to share the business you’re your former partner’s spouse? Most of the time, the answer to this question is “no.”

To avoid headaches and save significant legal and accounting expenses, we recommend including buy-sell provisions in the operating and shareholders agreements or entering into a stand-alone buy-sell agreement.

Buy-sell agreements are meant to arrange the procedures to follow once one of these events occurs and to pre-establish the former partner’s financial liquidation formula, thus reducing the risk of litigation.

First, the triggering events need to be clearly outlined: death and disability are arguably the most common, but the language should be tailored to the business’s specific needs. For instance, if one of the partners is merely silent, the other partners might not have a problem continuing the business with the former partner’s heirs. Other events often included are retirement, termination, bankruptcy, or failure to meet an obligation with the company, such as additional capital contribution.

One of the most important provisions we typically recommend to meet these goals is an option for the company to purchase the former partner’s shares or membership interest at a pre-determined purchase price or to be determined by an independent appraiser. This should be accompanied by the company taking out an insurance policy to have the money needed to purchase the former partner’s share of the business. We also recommend our clients to consult with a certified public accountant (CPA) to craft the clause providing for the valuation properly.

With respect to the terms of payment, installment plans are very popular, establishing that a portion of the purchase price will be paid at closing, while the remaining part will be in one or more installments throughout the following months or years.

We strive to make our clients appreciate the value of buy-sell agreements from the beginning. It is true that this entails spending more on legal fees for most unlikely events. However, the company becomes intrinsically more valuable, as the higher degree of certainty in the relationship among the partners attracts new investors. Finally, as already explained above, without a properly drafted buy-sell agreement or clause, the risk of incurring significant legal and accounting fees in the future is considerable.

Author:

  • Michele Cea, Esq.Founding Member & Managing Attorney, CEA LEGAL P.C.
  • Email: info@cealegal.com, Phone: (212) 618 1644

Compliments of CEA Legal P.C. – a member of the EACCNY.