Partnership Buy-in Agreement: Everything You Need to Know
Partnership buy-in agreement is a contract between the partners in a business detailing what happens to the ownership equity after a partner exits the company.3 min read
2. What Is a Buysell Agreement?
3. Events That Trigger a Buyout Option
4. Why Do You Need a Buyout Agreement
5. The "ABCs" of Buysell Agreements
Updated November 11, 2020:
Partnership buy-in agreement, also known as buy-sell, is a contract between the partners in a business detailing what happens to the ownership equity after a partner exits the company. It is important to note that a partnership buy-in is legally binding on all partners, making it essential to understand the terms before signing.
The Importance of a Buysell Agreement/Buyout Agreement
A buy-sell agreement or buyout agreement helps partners in a business plan for the future exit of a partner from the enterprise. A buyout agreement helps to prevent misunderstandings over ownership if a partner wants to leave the business, gets divorced, or dies.
What Is a Buysell Agreement?
A buy-sell agreement, also known as a buyout agreement is a contract entered into by business partners to manage future ownership issues and partnership change. Despite the name, a buy-sell agreement is not concerned with buying or selling a partnership business. A buyout agreement is legally binding and can be drafted as a standalone document or as part of the partnership agreement.
A buyout agreement should cover the following business decisions:
- Whether other partners can buy out the equity of another partner when he or she leaves the enterprise.
- The value of an ownership interest when a partner departs.
- Who is eligible to buyout a partnership interest when a partner leaves.
- Trigger events for a buyout.
A buyout agreement is like the business equivalent of a prenuptial agreement. It prepares the partners for future eventualities even though they hope for the business to exist perpetually.
Events That Trigger a Buyout Option
Many events can trigger a buyout option. They include:
- A retiring partner.
- A divorce settlement, which involves one partner transferring ownership equity in the business to the other spouse.
- When a partner agrees to sell their ownership interest in the business to an outsider.
- A partner who filed for personal bankruptcy.
- A foreclosure of a debt, which was obtained using a partnership interest as collateral.
- When a partner dies, suffers permanent disability or incapacity.
Why Do You Need a Buyout Agreement
A buyout agreement is essential for several reasons, which include:
- If there is a partnership change, a buyout agreement serves as proof of the decision partners have agreed upon regarding the ownership of the business when such an event occurs.
- In the absence of a buyout agreement, the partnership may face a legal dissolution and every partner will be forced to start a new business.
- It helps prevent disputes over the ownership of the business after the departure of a partner.
- It helps to avoid costly lawsuits arising from disagreements over the valuation formula for selling the business interests when a partner exits the partnership.
- Buyout agreements specify the outsiders who are eligible to buy ownership interests of a partnership, thus helping partners avoid working with people they do not like.
The "ABCs" of Buysell Agreements
Most long-term partnerships usually fail to consider the fate of the business if a partner experiences a life-changing event. For instance, what happens to the company if a partner had an accident and suffered permanent disability?
Generally, the interest of a deceased partner passes on to his/her heir if there is no written plan on what to do. However, the deceased's heirs such as the children or spouse usually lack experience or interest in becoming a partner in the business. This makes it essential to compensate for the exiting partner's family adequately while still running the business smoothly.
In the absence of a written succession plan agreed upon by all the partners, the matter may become a legal struggle that will cost you vast amounts of money, and in some cases the business. Most partners would instead choose their partners than leaving the fate of their business to outsiders.
Buy-sell agreements often cover the "four Ds" including death, disability, divorce, and departure of a partner. However, the contract can also touch on other circumstances that can result in the departure of a partner such as resignation, retirement, expulsion, and third party sale.
Some people use their estate plan to distribute partnership interests before their demise. However, this is not advisable for the following reasons:
- These provisions have no input from other partners and could lead to potential disputes when the time comes for succession.
- Estate plans are amendable after the death of the owner and can confuse partners on how to transfer partnership interests.
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