Owners of closely held businesses always want to control the dispersion of the ownership interests of their businesses. For this reason, contractual agreements are often made restricting the transfer of ownership of the business – buying or selling – as well as establishing methodologies for valuing those ownership interests. These contractual agreements are called buy sell agreements.

A buy sell agreement is a contractual agreement that not only restricts the transfer of ownership of a business but also establishes methodologies for valuing those ownership assets.

Whether the business is a formal partnership or corporation, situations frequently arise where one owner will need to sell his or her ownership interest. Sales of ownership interests are common not only in goods-producing businesses but also in service-producing businesses, such as medical or legal practices. A buy sell agreement sets forth the terms for all future purchases and sales of ownership of the business.

The contractual formula in buy sell agreements for determining ownership value often appears to be very simple. The formula, at least in principle, is tied to more complex formulas used in formal business valuations. However, when buy sell agreements are initially developed or revised, formal valuations are generally conducted to assure the owners that the contractually agreed-upon formula accurately reflects the value of the business.

A carefully drafted buy sell agreement is a valuable tool that can ensure the financial security of the business owners and their families. At the same time, the buy sell agreement allows the business to continue in a normal manner with a qualified and motivated management group at the helm.

The specific provisions of the buy sell agreement must be tailored to satisfy the needs and objectives of the individuals and the business. The general goals, however, are to provide the cash so that the decedent’s interest in the company may be purchased and the business may continue to operate smoothly.

Of paramount importance in drafting a buy sell agreement is providing for the value of each shareholder’s interest in the business and determining what price is to be paid for such interest. The agreement should contain a mechanism, to establish the value of the business which will apply to all dispositions of a shareholder’s ownership interest.

The buy-sell agreement may fix the value of the business by consent of the parties at a predetermined price, approximating fair market value, or by formula. If the parties agree upon a specific value, then the agreement must further provide that the parties will periodically reexamine the corporation’s value and certify any changes in such value.

There are two basic types of buy-sell agreements: entity-purchase and cross-purchase. Under the former, the business is a party to the contract with the owners and the business ultimately purchases the decedent’s stock. On the other hand, the cross-purchase form of agreement is entered into by the individual owners without involvement of the business.

A buy sell agreement will have no practical benefit unless the purchaser can finance the purchase price. The purchase price can be paid in a number of ways. Provision can also be made for installment payments of the purchase price.

Buy sell agreements ensure that the closely held business continues even after the death of an owner or when an owner decides to quit the business. It ensures that the other owners can continue operating the business after buying the share of that owner. The agreement keeps the stock in the hands of those active in the business and out of the hands of relatives and other outsiders who may not be so interested.