by Bethany K. Laurence

A buyout agreement lets you plan what will happen when a partner leaves the business.

Many new partners neglect to make a buyout, or buy-sell, agreement, but they are critical to protect your investment in a partnership. When you create buyout provisions for your partnership agreement, you and your partners will be prepared if one partner wants to leave the business, or worse, dies, goes bankrupt, or gets divorced.

What Is a Buyout, or Buy-Sell, Agreement?

Contrary to popular belief, a buy-sell agreement is not about buying and selling companies. It is a binding contract between business partners about the future ownership of the business. Because of this confusing terminology, we will use the term buyout agreement from now on.

A buyout agreement can stand on its own or can be several provisions in your written partnership agreement that control the following business decisions:

• whether a departing partner must be bought out
• what price will be paid for the departing partner's interest in the partnership
• who can buy the departing partner's share of the business (this may include outsiders or be limited to other partners), and
• what other events may trigger a buyout.

It may help to think of a buyout agreement as a sort of "prenuptial agreement" between you and your partners: Although you might think that your partnership will last as long as you all shall live, the buyout determines what will happen if things don't go exactly as you planned.

Events Covered Under a Buyout Agreement

Typically, the events that trigger a buy out of a partner's interest under a buyout agreement are:

• the retirement or resignation of a partner
• an attractive offer from an outsider to purchase a partner's interest in the company
• a divorce settlement in which a partner's ex-spouse stands to receive a partnership interest in the company
• the foreclosure of a debt secured by a partnership interest
• the personal bankruptcy of a partner, or
• the disability, death, or incapacity of a partner.

Why You Need a Buyout Agreement

Your buyout agreement will instruct and remind you and your partners how you have agreed to handle the sale or buyback of an ownership interest when one partner's circumstances change. Without one, if one partner quits to move to another city or leaves to start another business, your partnership might, by law, be dissolved, forcing you to divide any assets and profits among the partners and decide whether to start a new partnership with the remaining partners.

Even if your partnership doesn't end, you may still have an argument over whether you should buy out the departing partner's ownership interest, and for how much. If you don't anticipate and plan for circumstances like these, you risk serious personal and business discord -- perhaps even court battles and the loss of your business.

In addition, a buyout agreement can control who can buy into the partnership. Otherwise, you might be stuck sharing control of the company with someone you would rather not run a business with.

How to Create a Buyout Agreement

For a fill-in-the-blanks buyout agreement and instructions on how to incorporate it into your partnership agreement, see Business Buyout Agreements: A Step-by-Step Guide for Co-Owners, by attorneys Anthony Mancuso and Bethany K. Laurence (Nolo).