3 Common Mistakes Found in Buy-Sell Agreements

Sep 30, 2016

A buy-sell agreement, also known as a buyout agreement, is a legally binding agreement among co-owners of a business. It provides how the interest of an owner will transfer upon some event (often death or disability of the owner). If not properly drafted, a buy-sell agreement may be incomplete or may contain ambiguous terms.

The following are common mistakes found in buy-sell agreements: 

(1) Lack of Funding

An unfunded buy-sell agreement may not be worth much. Typically, buy-sell agreements are funded with insurance policies upon execution. The amount of coverage may change from startup and growth phases of the business, requiring an adjustment in the appropriate amount of coverage. To ensure effective and appropriate funding, a three-way conversation can be helpful among the parties of the agreement, the insurance agent, and the attorney drafting the agreement.

(2) Fixed Valuation

Buy-sell agreements should be considered at the time the business is formed if there are multiple parties involved (even if it is just involves family members). Implementing a fixed valuation can lead to deficient and incongruous amount because the value of the business will likely change over time. Consequently, the owners can use a formula or require a third-party valuation to account for changing values. It can also be helpful for business owners to review the agreement annually to ensure that the stated values or formulas in the agreement continue to serve the interests of the parties. 

(3) Insufficient Planning

An appropriate amount of time and effort should be allotted in the planning stage for a buy-sell agreement. The party should consider scenarios that involve, for example, the death, disability, or even the effects of a divorce between an owner and their spouse. Including legal counsel when planning to implement a buy-sell agreement can help ensure that the intent of the parties is accurately reflected in the agreement and that the parties’ interests are protected.

By: Heliane Fabian