Buy-Sell Agreements should be a required part of your investing plans.
I have often said that the number-one mistake made by all new real estate investors is that they buy the real estate in their own name, instead of buying it in the name of a business entity which they own.
I have also said that the number two mistake is using the wrong business entity when buying the real estate.
Today, we’ll talk about mistake number three.
And it is the failure to have a Buy-Sell Agreement in place with the co-owners of the property.
How serious is this?
Well, I have seen situations that lead to divorce, family alienation, and, of course, lawsuits.
All of the trouble could have been easily avoided, and now I’ll show you how.
So, let’s get started.
BUY-SELL AGREEMENTS
A Buy-Sell Agreement is a written contract between, and sometimes among, the owners of interest in a legal entity.
The owners are usually the Shareholders of a corporation, Partners in a Partnership, or members of a Limited Liability Company.
The Agreement provides that, upon the occurrence of a certain identified event, the ownership of the interests will be subject to transfer in a specified manner.
Let me say that again.
You have more than one owner of a business entity, and the business entity owns the real estate investment.
If something happens affecting one owner, or all of the owners, of the business, then ownership will change in a way that is written out and explained in the Agreement.
BUY-SELL AGREEMENTS EXAMPLE
In Real Estate Investing, these Buy-Sell Agreements are normally used when you set up a Limited Liability Company (LLC) with another person, and each of you own a 50% interest.
Now, in the event that the other person dies, you probably don’t want to then be in business with whoever inherits that other interest, the wife, the children’s Guardian, or the Administrator of the person’s Estate.
So, you want to have a Buy-Sell Agreement that says that you have the right to purchase the other person’s interest at a specified price and under specified terms, and the other parties have to go along with that because it has already been agreed to and outlined in a contract, the Buy-Sell Agreement.
A Buy-Sell Agreement is also used to cover other eventualities, such as one of the owners filing for Bankruptcy protection, or just wants to leave the business.
BUY-SELL AGREEMENTS TERMS
The Buy-Sell Agreement might say that you will purchase the interests of the other party for the dollar amount of that party’s Capital Account.
Capital Account is an accounting technique that keeps track of each party’s claim on the assets of the business, similar to Equity, but not exactly.
Or you might agree to pay ten times the average amount of Net Income of the business for the prior five years, or a similar formula.
And, instead of paying cash, you might be permitted to sign a Promissory Note for the amount, payable over a certain period of time, at a certain interest rate.
A Buy-Sell Agreement should be signed by all of the parties who own an interest in the business, and who might have an interest in the outcome of the event described as triggering the Agreement.
That means, if death is one of the events contemplated, the Agreement should also be signed by the spouse and/or potential heirs. You can get by without that in some States, if the Agreement is carefully worded, but not in other States. In States with “community property” laws, make sure that you always have the spouse sign the Agreement, because the Buy-Sell Agreement will have terms that contradict that State’s Community Property Laws upon death.
OTHER BUY-SELL AGREEMENTS USES
And there are other reasons to use a Buy-Sell Agreement.
I have seen them also used to try to deal with the possibility of business disagreements between the owners.
But in these cases, they almost never work out in dealing with the problem.
Each party still has the option of filing a lawsuit, and one of the parties usually does file.
And then the other party counter-sues.
And then you spend three years trying to get to Court, with one of the parties trying to delay as long as possible.
So, these situations, possible business disagreements between the owners, are better handled with the language in another Agreement that you will have also signed, the LLC Operating Agreement or the Partnership Agreement.
Of, if it is a corporation, in the Corporate By-Laws.
Nail them down there, and if there is a disagreement, the Judge will know exactly how to rule on the issue.
A Buy-Sell Agreement is best used to deal with unforeseen events, which you know will cause complications, and which you want to avoid or be able to smooth out.
A good Buy-Sell Agreement can save you trouble that you cannot imagine.
RELATED POSTS
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A Living Trust Is Not A Trust.
RESOURCES
I touch on this same concept in more than one of my books, but the one with the most detailed information is “Do This, Not That!” If you would like to preview it, you can go here on this website to look at it first, use the 3D Flip Reader to look at the Contents and read the first few chapters.
The paperback is available on my Amazon Author Page, along with my other books.
And I have related Articles about real estate investing and other real estate matters from other perspectives on my LinkedIn Page.
I am also active on Quora.com where I have answered over 300 questions, and they have almost 3 Million views.
If you happen to be doing, or if you are considering doing, a Section 1031 Like Kind Exchange, then you should start with a Dictionary, and I have done one, in 3 separate Blog Posts here: Part 1, Part 2, and Part 3. And I have a lot of material for you to consider on my S1031 Exchange website.
You should always check out the credentials of anyone, like myself, who you are relying on for accurate information by looking closely at their Biography. Here’s mine.
And if you think you might like to read one of my books, but can’t decide which one, here are four that I recommend.
DISCLAIMER
I am an Attorney licensed to practice in Texas, North Carolina, Virginia, and the District of Columbia. But I am not your Attorney. I would be honored if I were, but I am not. Reading this Blog does not created an attorney-client relationship between us. Internet content should not be used as a substitute for the advice of a competent Attorney admitted or authorized to practice law in your state or jurisdiction.
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