What is a Buy/Sell Option Agreement?

What is a Buy/Sell Option Agreement?

In any business, the partners are the most important asset for the business. If something happens to you or your partner(s), then you must plan for the future to ensure that a proper succession plan is in place. If you are in business with a business partner, you must think about the consequences if you or one of your partners unexpectedly dies or is disabled to the point that they can no longer function in your business.

Generally, partners in a business or directors and shareholders in a company enter into an agreement that governs the parties’ day-to-day relationship. These are generally partnership agreements and/or shareholders agreements. The purpose of these agreements is to set out the rights and obligations of the parties generally and to set the rules for the operation of the business.

These agreements, generally, do not set out the rules for dealing with the parties when something happens to a partner that impedes them from being able to operate in the business. Generally speaking, the consequence of this is that the deceased or injured parties family will have the right to get involved in the business; this can be the case even when they have little or no experience in the business.

A buy/sell agreement is a contract entered into between business partners pursuant to which the surviving party is bound to buy out the other parties interest in the business should a specific event occur. Particular events which may trigger a buy/sell agreement include death, long-term disability, retirement or bankruptcy. Often, the parties take out an insurance policy on each other party’s life, allowing the surviving party to buy out the other party’s interest.

Strategy Analysis

 
A business may be transferred on the death of an owner either by:

• gifting the business via a will; or

• selling the business via a buy/sell agreement

The buy/sell agreement will take precedence over the will because the business will be transferred pursuant to the contract.

Funding the Agreement

The buy/sell agreement is usually funded through an insurance policy. However, the parties must consider the consequences if that insurance policy is not honoured by the insurance company or cancelled for a reason outside the parties’ control.

Important consideration should be given to the value placed on the person’s interest in the business. Usually, parties either agree on a figure or arrange for a valuation of the business. The advantage of this approach is that it allows the insurance policy to be upgraded without the need for the parties to amend the option contract.

At SMS Law, our team of solicitors have extensive legal experience. We know the legal system can feel overwhelming, and it is hard to feel confident when you don’t know how to move forward. That’s where we step in, to guide you through each step of the legal process.

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