Buy-sell agreements, sometimes called buyout agreements, are legal agreements between two owners of a business specifying how one owner can buy the other owner’s interest. If you are thinking of buying out a partner or selling your portion of a business, review the important key components of a buy-sell agreement. If you just formed a partnership, now is the time to develop a buy-sell agreement to protect each of your interests in the business.
A buyout agreement should clearly specify under what conditions a partner is allowed to sell his interest in the business and who will be allowed to purchase part of the business. For example, if an owner has a serious health condition, he could be permitted to sell the business. “Serious health condition” must be clearly defined. Other situations that can arise would be divorce, death, bankruptcy or retirement.
One key component of the agreement is the valuation of the business. The buyout price can be fixed and that amount is specified. Another option is book value, which is the value of the business shown on the balance sheet less any depreciation that has accumulated. Most businesses have value higher than book value. For example, there’s added value from the number of customers a business has and related goodwill. Because of this, another valuation technique is to use a multiple of book value. In many industries, there is a standard guideline for what multiple to use. Since every business is different, industry guidelines should only be used as a starting point. Another valuation technique is to have the business appraised at the time of buyout by a professional appraiser. This allows for the final price to reflect changes in the marketplace.
The buy-sell agreement should specify if the seller of the business is obligated to spend additional time working in the business after the transaction is complete to insure a smooth transition in the business ownership. The agreement should also indicate how payments will be made for the buyout. Will a lump-sum payment be made or a series of payments over time? Will the buyer be charged interest for the right to make payments over time? The remedy the seller has should the buyer not make payment on time should be indicated.
The partner selling the business should agree that he will not disclose company confidential information to outside parties, such as competitors, and that he will not retain confidential company information, such as a customer list. It is common practice to ask the partner selling the business to not work for or begin another business that directly competes with the business he is selling for a specified number of years.