A buy-sell agreement prevents things from becoming complicated when a co-owner of a business leaves and shouldn’t only cover planned exits. There are many scenarios in which things can go south between owners or an emergency arises. Numerous disasters can arise on the back end of a business partner leaving the business.
Here are a few common scenarios that a buy-sell agreement prevents:
- A business partner dies, retires, gets divorced, or goes bankrupt and is replaced by someone unsuitable. The new partner could be the former partner’s spouse or child, or a complete stranger. He or she could be someone who had a minimal role in the business or no prior involvement whatsoever and now he or she has the same authority over the business as the departing partner.
- A retirement is obstructed because the co-owners undervalue the retiring partner’s interest. A partner is relying on cashing in on years of hard work only to find his sale blocked. There’s a limited market for the partner’s interest and his co-owners know it. Consequently, they offer less than a fair price. A valuation done as part of a buy-sell agreement makes the exit less susceptible to under-valuation and dispute. Heirs could face the same problem in the event of a partner’s death. Their surviving spouse and children could end up with a fraction of the value owed
- The co-owners terminate an owner-employee who is performing poorly. The owner-employee still has rights to the business. Just because someone is voted out by other owners and so no longer has specific job responsibilities, the individual does not automatically forgo his or her interest in the business. A disgruntled individual can hamper growth and extort the remaining owners.
Issues the Buy-Sell Agreement Should Address
To accomplish a smooth ownership transition and avoid situations like those described above, a buy-sell agreement should deal with the following issues:
- Sales of interests that are permissible, not permissible, and mandatory.
- The events that trigger the buy-sell agreement.
- Who the buyer will be for a departing owner’s interest: the other owners; the business; a third party with the other owners’ consent or after owners pass on a right of first refusal.
- How the price of the departing owner’s interest will be determined.
- How the payment of the price is to be funded.
- Payment terms
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Disclaimer: This article is intended to serve as a general summary of the issues outlined therein. While this article may include general guidance, it is not intended as, nor is a substitute for, qualified legal advice. Your review or receipt of this article by Lexern Law Offices, Ltd. (the “LLG”) or any of its attorneys does not create an attorney-client relationship between you and the LLG. The opinions expressed in this article are those of the authors of the article and does not reflect the opinion of the LLG.