What’s an Entity Agreement?

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An entity agreement, also called a purchase agreement, is a binding contract between business owners that establishes the right to buy back the retiring owner’s interest in the company. This is typically used with partnerships or limited liability companies (LLCs) where the interest is tightly held and is never intended to be sold to a third party. The entity agreement ensures that if a partner has to leave the company for any reason, its ownership interests are purchased by the remaining owners, rather than being sold or transferred to a third party.

Ownership interests in partnerships and companies are not designed to be freely transferable to a third party. The law treats these types of commercial agreements as personal contracts between owners and adheres to the basic principle that one person cannot force another into a contract. Comparatively, ownership of a company is designed to be freely transferable to third parties, so shares are issued to owners who can be sold on an open market. When an owner must terminate a partnership or partnership for any reason, including disability or death, he may not necessarily sell or transfer his interest in the partnership at his discretion.

The laws governing the formation of business partnerships and LLCs allow owners to decide what will happen to an owner’s interest in the event that they have to retire from the partnership. Owners can enter into an entity agreement that sets out the procedure for the remaining owners to buy back the retiring owner’s interests. This agreement can be a separate document or it can be part of the company’s operating agreement that deals with owner relations beyond the issue of termination.

Typically, an entity agreement sets out the terms for the repurchase. More importantly, it should establish a way to gauge a landlord’s interest at the time of sale to avoid valuation disputes. Close business interests are often difficult to value without selling the business due to the lack of a third party commercial market, such as the stock markets that companies use to determine the value of individual shares. Without a provision as to how to arrive at the price the remaining owners will pay to buy the withdrawing owner, the withdrawing owner may refuse to sell due to an undersupply.

Courts consider an entity contract to be a binding contract. It is important to realize that the withdrawing member does not necessarily have to accept the provisions of the purchase agreement to be effective. Most jurisdictions require landlords to subject government provisions to a property vote. If a majority of owners vote to implement an entity agreement that controls how the company buys back ownership interests, it is binding on all owners.

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