What are the best practices for drafting and executing a buy-sell agreement?

2 Choose the type of agreement

The next step is to choose the type of buy-sell agreement that best suits the needs and goals of the parties. There are two main types of buy-sell agreements: a cross-purchase agreement and a redemption agreement. In a cross-purchase agreement, the remaining owners agree to buy out the departing owner's shares or interests. In a redemption agreement, the business entity agrees to buy back the departing owner's shares or interests. Each type has its own advantages and disadvantages, such as tax implications, funding options, and valuation methods. The parties should consult with their legal and financial advisors to determine which type is more appropriate for their situation.

3 Set the price and terms

The third step is to set the price and terms of the buy-sell agreement, such as how the business will be valued, how the payment will be made, and how the transfer will be completed. The price and terms should be fair, reasonable, and consistent with the market conditions and the expectations of the parties. The parties should also consider various factors that may affect the value of the business, such as its assets, liabilities, income, growth potential, goodwill, and industry trends. The parties should also agree on a valuation formula or method that will be used to determine the price at the time of the triggering event, such as a fixed price, a book value, a multiple of earnings, or an appraisal.

4 Specify the triggering events

The fourth step is to specify the triggering events that will activate the buy-sell agreement, such as death, disability, retirement, divorce, bankruptcy, or disagreement. The triggering events should be clearly defined and mutually agreed upon by the parties. The parties should also consider the consequences and contingencies of each triggering event, such as how the sale will be funded, how the taxes will be handled, and how the rights and obligations of the parties will be affected. The parties should also review and update their estate planning documents, such as wills, trusts, and beneficiary designations, to ensure they are consistent with the buy-sell agreement.

5 Fund the agreement

The fifth step is to fund the buy-sell agreement, which means to ensure that there is enough money available to buy out the departing owner's shares or interests. There are different ways to fund a buy-sell agreement, such as using cash, borrowing money, selling assets, or obtaining insurance. The most common and convenient way is to use life insurance or disability insurance, which can provide a lump sum payment to the buyer or the seller in case of death or disability. The parties should compare and evaluate different types of insurance policies, such as term, whole, or universal, and determine who will own, pay for, and benefit from them.

6 Review and update the agreement

The sixth step is to review and update the buy-sell agreement periodically, or whenever there is a significant change in the business or the personal circumstances of the parties. The review and update process should involve the parties and their legal and financial advisors, who can help ensure that the agreement is still valid, enforceable, and aligned with the current goals and needs of the parties. The review and update process should also consider any changes in the laws, regulations, or market conditions that may affect the buy-sell agreement, such as tax laws, valuation standards, or industry trends.

7 Here’s what else to consider

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