The Future Success of Your Business or Real Estate Holdings May Hinge on a Proper Buy-Sell Agreement Between Owners
Buy-sell agreements are invaluable agreements between co-owners of a business, corporation, or LLC.
In companies with multiple owners, buy-sell agreements outline the terms for the sale, assignment, or transfer of ownership among one or more of the owners of the enterprise. Buy-sell agreements typically dictate who has the first right to acquire the departing owners’ interest, how much will be paid to the departing owner for their interest, and the terms of funding the purchase. A properly written buy-sell agreement is key to business succession planning because it helps assure a smoother operations transition when one owner retires or departs the business.
There are two basic types of buy-sell agreements.
Corporate, LLC Redemption Buy-Sell Agreement
The first is a redemption buy-sell agreement. This is an agreement in which the business entity itself (i.e., an LLC or corporation) purchases the departing owner’s interest. This means the remaining owners hold a larger share of the business. In effect, it reallocates each member’s or shareholder’s ownership percentage.
Cross-Purchase Buy-Sell Agreement
A cross-purchase buy-sell agreement is the other basic type of buy-sell agreement. This involves the remaining owner or owners individually acquiring the departing owner’s interest. In businesses with multiple owners, it is possible for one owner to acquire all or most of the departing owner’s interest and thereby increase their ownership percentage in the business. Alternatively, all existing owners acquire an equal share of the departing owner’s interest, keeping the ownership percentages unchanged.
There are numerous benefits to buy-sell agreements for both your business and a departing owner. Guaranteeing a purchaser for a departing owner’s interest avoids the hassle of finding someone to buy out your interest. While this may not seem like a concern for a successful business, remaining owners often must approve any person or entity purchasing an interest in the business. Some owners may not want others to receive a larger ownership share in the business. These and other issues can be avoided in a written agreement by naming a buyer before it is listed for sale.
Buy-sell agreements allow owners to agree on financing for the transaction before it occurs, avoiding the trouble of forcing the departing member and a prospective buyer to go through unfamiliar financing methods. It also guarantees that the business will continue to operate as it has and will not be interrupted by conflicts arising from the departing owner’s transfer of ownership.
By establishing a valuation of the interest to be sold prior to departure, a buy-sell agreement also assures the heirs of a deceased business owner that they will receive a fair value for their loved one’s interest in the enterprise. Many family members have no idea what the deceased owner’s interest in the business is worth, and unfortunately, this leaves them vulnerable to being taken advantage of by the remaining owners. Setting a predetermined value for the business interest, which is frequently updated by the owners themselves, helps ensure that family members receive fair value, hopefully reducing potential arguments over its worth.
An agreed-upon valuation can also be used for tax purposes, as the government will allow the buy-sell agreement to establish the value of the business if three strict requirements are followed:
- The buy-sell agreement is a bona fide business agreement.
- The buy-sell agreement is clearly not an attempt to transfer your business interest to a family member for less than adequate consideration; and
- The terms of the buy-sell agreement are similar in structure and details to other conveyances of the same general type.
Fredrick P. Niemann Esq.
A proper buy-sell agreement between you and your co-owners can be critical to the future succession of your business in New Jersey. When properly drafted, these agreements ensure the successful transfer of your business while avoiding the tedious conflicts that tend to arise without them.
Please note that the discussion on this page, while frequently making reference to a business, applies equally to real estate holdings and their owners.
If you have any questions regarding the benefits of a buy-sell agreement or would like to discuss the future of your business succession planning, please call Fredrick P. Niemann, Esq., a knowledgeable NJ Business and Estate Planning Attorney. He can be reached at (732) 863-9900 or by email at fniemann@hnlawfirm.com. You’ll be happy to know that he is very approachable and experienced in New Jersey business and estate planning.
Written by Fredrick P. Niemann, Esq. of Hanlon Niemann & Wright, a New Jersey Business Law Attorney