{"id":4824,"date":"2016-04-04T10:47:45","date_gmt":"2016-04-04T15:47:45","guid":{"rendered":"https:\/\/content.findlaw-admin.com\/ability-law\/smallbusiness\/incorporation-and-legal-structures\/faq-regarding-buy-sell-agreements.html"},"modified":"2025-10-29T22:42:00","modified_gmt":"2025-10-30T03:42:00","slug":"faq-regarding-buy-sell-agreements","status":"publish","type":"page","link":"https:\/\/www.findlaw.com\/smallbusiness\/incorporation-and-legal-structures\/faq-regarding-buy-sell-agreements.html","title":{"rendered":"FAQ Regarding Buy Sell Agreements"},"content":{"rendered":"\n
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FAQ Regarding Buy Sell Agreements<\/h1>\n\n
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\n By FindLaw Staff<\/a> | Legally reviewed by Catherine Hodder, Esq.<\/a>\n | Last updated\n
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This article has been written and reviewed for legal accuracy, clarity, and style by FindLaw\u2019s team of legal writers and attorneys<\/a> and in accordance with our editorial standards<\/a>.<\/em><\/p>\n\n <\/div>\n <\/details>\n\n

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The last updated date refers to the last time this article was reviewed by FindLaw or one of our contributing authors<\/a>. We make every effort to keep our articles updated. For information regarding a specific legal issue affecting you, please contact an attorney in your area<\/a>.<\/em><\/p>\n\n <\/div>\n <\/details>\n<\/section>\n\n\n

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A buy-sell agreement<\/span> is a binding contract<\/span> that outlines how business interests<\/span> will be sold or transferred if a partner leaves the company. It sets forth triggering events<\/span>, buyout<\/span> pricing, and other provisions to continue the business.<\/p>\n\n <\/div>\n\n\n\n

Although you\u2019re just focused on building the business when you form a partnership<\/a>, nothing lasts forever and change is inevitable. If a partner leaves or falls ill and is unable to continue his or her functions, you want to make sure you have a contingency plan in place<\/a>.<\/p>\n

One of the best ways to prepare for change, both expected and unexpected, is to sign a buy-sell agreement<\/span> with the other partners. Below are answers to some of the most commonly asked questions about buy-sell agreements<\/span>.<\/p>\n

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When would a business need to have buy-sell agreements<\/span> in place?<\/h2>\n

Almost every business that is owned by more than one party (co-owned) should have a buy-sell agreement<\/span> (also called a buyout<\/span> agreement<\/span><\/a>) in place at the moment the business is formed or as soon as possible after that point. Each day that a business continues to operate without a buy-sell agreement<\/span> increases the financial risk.<\/p>\n

If there was a triggering event<\/span>, such as the death or disability of a partner, the company has a mechanism for continuing operations. It could outline provisions where current partners have the right of first refusal<\/span> to buy out<\/span> the other owner\u2019s share<\/span> before other buyers could come in.<\/p>\n

Are buy-sell agreements<\/span> used for buying and selling businesses?<\/h2>\n

Despite its simple name, no, buy-sell agreements<\/span> generally have very little to do with the buying and selling of businesses. Instead, buy-sell agreements<\/span> are contracts that link co-owners<\/span> of businesses together and controls when owners can sell their respective interests in a company or business. In addition, these agreements dictate who can buy an owner\u2019s interest<\/span> in a company and also sets the price at which the interest will be sold.<\/p>\n

Buy-sell agreements<\/span> only come into force when an owner of a business dies, retires, is bankrupted, becomes disabled or is divorced. Likening a buy-sell agreement<\/span> to a prenuptial agreement<\/span> is a valid comparison \u2014 they govern when a co-owner<\/span> is getting out of the business just like when a couple is getting out of a marriage. Buy-sell agreements<\/span> generally cover only transactions that occur between the business owners<\/span>, which is why they are sometimes referred to merely as buyout<\/span> agreements<\/span>.<\/p>\n

When a married co-owner<\/span> of a business<\/span> gets divorced, can the former spouse<\/span> ask for partial ownership of the business or company?<\/h2>\n

It depends on the state that you live in and the type of marital property<\/span> law<\/a> your state follows. If your state follows a community property law system (like California, Arizona, Nevada and others), then all earnings that are made (and property acquired) during a marriage are considered the property of the “community,” meaning both spouses. Upon a divorce, the community property is split between the two spouses (absent a contradictory and valid prenup), so a former spouse<\/span> may ask for partial ownership of a business.<\/p>\n

In non-community property states<\/span>, an ex-spouse<\/span> may still make a strong argument for being granted partial ownership of a business that the other spouse was a co-owner<\/span> of. This is because property laws require that marital property<\/span> be divided equitably upon divorce.<\/p>\n

Because of these laws, a good buy-sell agreement<\/span> will adopt provisions that prevent former spouses<\/span> from taking an ownership interest<\/span> in the company on divorce from a co-owner<\/span>. The agreements do this by requiring any former spouse<\/span> who gets a property interest through divorce to sell that property interest back to the company or to other co-owners<\/span> in exchange for cash or other valuable property.<\/p>\n

If a co-owner<\/span> files for personal bankruptcy<\/span>, can this affect the business?<\/h2>\n

If the controlling buy-sell agreement<\/span> is not carefully drafted, then yes, a personal bankruptcy<\/span> could impact a business. If a co-owner<\/span> does not have enough assets to cover his bankruptcy, the bankruptcy trustee<\/span> may gain control and sell the co-<\/span>owner<\/span>\u2019s share<\/span> of the assets and use the profits to satisfy the debts. Because of this risk, most buy-sell agreements<\/span> contain clauses that deal with such situations.<\/p>\n

Typically, if a co-owner<\/span> is about to file for bankruptcy, he must inform all the other co-owners<\/span> of his situation. This then is treated as an offer to sell his ownership interest<\/span> in the company back to the other owners. The money that is paid in this buyout<\/span> goes towards the co-owner<\/span>\u2019s bankruptcy case.<\/p>\n

Is there a best way to value a company when a co-owner<\/span> is being bought out?<\/h2>\n

Perhaps the most accurate way of determining the value of a company when a co-owner<\/span> is being bought out is to hire an appraiser<\/span> at the time of sale<\/span>. The appraiser<\/span> will need to see at least one year of business records to make his decision. However, when a buy-sell agreement<\/span> allows this to happen, what often results is that many owners hire their own appraisers<\/span> who all come up with different valuation<\/span> formulas<\/span>.<\/p>\n

To avoid this problem, it is often best to adopt a valuation<\/span> method<\/span> that will go into the wording of the buy-sell agreement<\/span>. By doing so at the outset, this allows all the owners of the business to discuss and come up with an agreed upon valuation<\/span> formula<\/span>. If a formula is already set when it comes time to buy out<\/span> an owner, it can save a lot of time and effort that would otherwise be wasted in picking and choosing between competing valuation<\/span> formulas<\/span>.<\/p>\n

What happens if a company finds it necessary to buy out<\/span> an owner but cannot afford to do so?<\/h2>\n

This often happens when a buy-sell agreement<\/span> requires that an immediate, 100% lump sum<\/span> be paid to an owner when it comes time for sale. It is often worthwhile to draft a more flexible payment scheme into the buy-sell agreement<\/span>. Instead of requiring a 100% lump sum<\/span>, allow a down payment<\/span> on buyout<\/span> between 25 and 35% of the value of the ownership interest<\/span> up front with installment payments<\/span> coming after for a period of three to five years.<\/p>\n

Can buy-sell agreements<\/span> allow a person to reduce estate taxes<\/span>?<\/h2>\n

Yes. A buy-sell agreement<\/span> is a good estate planning<\/span> tool. By carefully drafting a buy-sell agreement<\/span>, you may be able to reduce any potential estate <\/span>taxes<\/span><\/a> that you may owe at your death. If you are interested in using a buy-sell agreement<\/span> to lessen or avoid any estate taxes<\/span>, you should consult with an experienced tax attorney to find out your best options.<\/p>\n

Do I need help from an attorney when drafting a buy-sell agreement<\/span>?<\/h2>\n

It certainly doesn\u2019t hurt to have an attorney help you draft \u2014 or at least review \u2014 a buy-sell agreement<\/span> before the parties sign on. Even if you are absolutely confident about the terms of your buy-sell agreement<\/span>, it may still be a good idea to get legal advice<\/span> from a lawyer. Check FindLaw\u2019s lawyer directory to find a business organizations attorney<\/a> near you.<\/p>\n

See FindLaw\u2019s Partnerships<\/a> section for additional articles and resources.<\/p>\n\n\n

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