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The basics of buy-sell agreements, Part I: What they are

There are advantages to starting a business with one or more other people, as compared to going it alone. For starters, sharing the work and financial risk is easier with co-owners. Unfortunately, however, there are also some risks involved. This includes uncertainty about what happens to the business when a co-owner experiences a major change in life circumstances and leaves the business.

A business can easily run into trouble when a co-owner dies, becomes disabled or even goes through a bitter divorce. In order to protect the business against the uncertain fortunes of each co-owner, a buy-sell agreement may be necessary.

So what are buy-sell agreements? In short, they are a pre-planned strategy for transferring ownership of a business when one or more co-owners are no longer able to maintain a stake in the business. They reduce disruptions that the business may experience as a result of a key partner's exit.

The benefits and protections offered by buy-sell agreements are numerous. They include:

  • A way to ensure that the company remains owned only by those who helped build it
  • A way to ensure that the heirs of a deceased co-owner are compensated fairly for their interest in the business
  • A way to avoid acquiring business partners (usually family members) who don't understand the business or care about its success
  • A way to avoid or reduce conflict between remaining business partners
  • Protection against the financial consequences associated with uncertainty after the departure of a key owner

In many cases, buy-sell agreements have specified "triggering" events, including death and divorce. Please check back next week as we discuss common triggering events you may want to include in your agreement.

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