Buy-Sell Agreements
A buy-sell agreement, by whatever name, satisfies a two-fold purpose. First, the party who is selling their interest retains a liquidity for their investment, while secondly, the remaining owners control the identity of the ownership group, thus maintaining a “close” company.
Buy-sell agreements can take the form of either a company obligation, traditionally called a buy-sell agreement, or the remaining owners’ obligation, traditionally called a cross-purchase agreement. A hybrid, giving first the company, followed by the remaining owners, the obligation or option to purchase, is frequently found in a buy-sell agreement.
In a buy-sell agreement, there are a number of issues that are traditionally addressed, though company-specific issues can also be addressed in such an agreement. The traditional issues include the following:
- Restriction on transfer of interests without compliance with the agreement;
- Triggering events giving rise to either an option or mandatory purchase of the interest;
- Valuation methodology;
- Payout provisions;
- Security for future payments; and
- Non-competition and confidentiality terms.
The restrictions on transfer prohibit an owner from offering to a third party such ownership interest without first offering that same interest to either or both the entity and/or remaining owners. Generally, if the company or remaining owners do not purchase the offered interest, that interest may be sold for a price not less than the price that the company or remaining owners would have had to pay.
The valuation of an owner’s interest in a company can be based upon any number of factors, from a book value (the definition of which should be spelled out in the buy-sell agreement), to a multiple of earnings, cash flow, appraisal of assets or going-concern value, or any other methodology that the owners agree upon, including a combination of any of the foregoing. In some situations, the owners agree that the value will be adjusted depending upon the triggering event, with termination from employment receiving the lowest valuation.
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