Does your business have a buy-sell agreement? Should it? The answer is yes, absolutely. It is prudent for all businesses, regardless of size or structure, to have a buy-sell agreement in place. The cost and effort to establish far outweigh the problems and headache that are likely to occur if there is no buy-sell agreement in place.
For example, let’s say you and your college friend start a side business with a hand shake deal to split profits 50/50. You jump through the hoops to get the business set up, such as creating a separate bank account and setting up the business entity type. However, you do not establish an understanding of what happens when either of you exit the business. Ten years later, the business is well established and you are receiving substantial income from the 50/50 split of profits. What happens if your partner tragically passes away? Do you automatically assume his half of the profits? Does his family? What happens if your biggest competitor approaches your partner and offers to buy his share? What if your partner decides he wants to retire and asks if you will buy him out? Who decides price? When and how is it determined? What if your partner wants to gift his share to their children who have no experience in the business? As you can see, even in the simplest example, there can be huge headaches that a buy-sell agreement can avoid.
The following is a list of fairly common circumstances where a buy-sell agreement would be extremely helpful and some considerations that should be included in the agreement in order to reduce conflict or disagreement.
Death or disability – This should be covered in all buy-sell agreements. Terms of this buyout should include determination of disability, time for payment to the owner or owner’s estate, who has the option or obligation to purchase the deceased owner’s interest and in what order, and are funding mechanisms such as life and/or disability insurance are required to be carried on shareholders and by whom.
Desire to sell the interest to a third party – The agreement should contain provisions that potential sales should be brought to the remaining owners and that they are given the following options:
- Chance to match the offer made by the third party
- Purchasing the shares in accordance with the valuation method and payment terms provided for in the agreement.
- Having the entity repurchase the shares issued in accordance with the valuation method provided for within the agreement.
Retirement of an owner – Provisions should be included in the agreement that describe purchase options of remaining owners upon retirement. These provisions should include conditions under which an owner may have the right to retire, when they can or have to retire, valuation process to determine cost of buyout and payment terms. These are especially important to define since no outside funds will be introduced as would be from life insurance proceeds or third party purchase of interest.
Owner’s divorce or bankruptcy – Either of these circumstances can subject the business to unwanted interference from outsides. Buy-sell agreement should contain provisions to compel the affected owner to sell their shares to the remaining owners or the entity itself, in accordance with the payment terms and valuation method.
Buy-sell agreements do not have to be extremely complex with page after page of provision for every possible circumstance. They should be custom tailored to fit each business’s specific needs and circumstances, and any agreement is better than no agreement. If you would like to discuss setting up a buy-sell agreement for your existing business or new start-up, please do not hesitate to contact us.