What would happen if your business partner decided to quit the business or worse, she just stopped showing up or embezzled from the company? (Kill her? Wrong answer!) What if she divorced and as part of the divorce settlement, the judge awarded her ex-husband half her interest in the company? Do you want to be in business with her ex-husband? (Kill him? Still the wrong answer!) What if your business partner is killed in a car accident?
Did you know her interest is the business is an inheritable asset? That you could end up being partners with a grieving spouse, children and possibly other assorted relatives? How do you handle these situations? A buy-sell agreement.
A buy-sell agreement is an agreement between owners of a company that spells out the terms and conditions for exiting the business or giving up partial ownership. In other words, it’s the “rules of engagement” for those situations. There are multiple considerations when preparing a buy-sell agreement and there is no such thing as a “one-size-fits-all”. There are nuances and twists and turns to putting one of these agreements together, but for simplicity sake, let’s consider just the basics.
First, most buy-sell provisions are triggered by some pre-defined event. So, what is that event? Typical “trigger events” include
- Death
- Divorce
- Bankruptcy
- Resignation
- Termination
- Disability
As you can imagine, these events bring up raw emotions (from extreme sadness to wanting to “lay hands” on one of your colleagues!). Clearly, this is not the time to try to negotiate a rational agreement about exit strategies. So, having one in place before you need it (like insurance!) is the better path.
Once the “trigger events” are defined, the next question is “HOW MUCH”? Well, the answer to that question depends on which side of the table you’re on. If you’re the one leaving the business, then you want to get paid as much as possible for your ownership interest. On the other hand, if you’re the one staying in the business, then clearly, you want to pay as little as possible.
Valuing the ownership interest is key. How do you do that? What is it worth? And once you put a dollar figure on it, how is the money paid and who gets first dibs on purchasing the interest? You? What if there are other owners remaining in the business—do they want to buy? The company? There are several choices.
- The company can have the first right to buy the ownership interest .
- Then, if it doesn’t exercise that right within the required time, the other owners can step in.
- Alternatively, the owners can agree to buy interests from each other.Or, the company can have the sole right to buy the interests.
As for valuing the company, the buy-sell agreement should spell out either a fixed, pre-determined price (CAUTION!!! Is the price you picked 5 years ago, or even last year, still the right price??), or use a formula to determine the best buy-out price based on the best metrics for your business or industry. Finally, the owners could agree to hire one or more appraisers to value the company (which can be expensive). Either way, there needs to be a pre-defined method of determining the price.
As you can see, these issues are best decided up front, when everyone is unemotional and getting along. Waiting until one of these trigger events occurs to try to figure this stuff out is way too late. So, consult with an experienced business law attorney now and get your buy-sell agreement in place!
