A buy-sell agreement, also referred to as a buyout agreement or business continuity agreement, is a contract that provides for the sale of an owner’s share of a business should certain events occur. When you start a business with one or more partners, your intention is to be in it for the long haul. If that partner is your friend, a new relationship evolves when you’re in business together. Friendships get stressed when friends become business partners – no matter how close you are before you start the business. And, while you plan to be in business with your current partner(s) indefinitely, it’s prudent to remember that nothing in business is forever, and having a buy-sell agreement in place at the outset is a smart business decision.
There are many events that can trigger the necessity for a buyout, including an owner’s retirement, bankruptcy, divorce, death, disability, changes (good or bad) within the families of owners, changes in career objectives, relocation, or a conflict with another owner that can’t be resolved. So it’s best to be prepared, not just hope for the best. The buyers that are party to the buy-sell agreement may be other owners, employees, or third parties.
Without a comprehensive buy-sell agreement, your business is vulnerable to a number of risks.
- It can land in the wrong hands – maybe those of an angry spouse or disgruntled previous owner.
- The business could die in the courts while ownership is being contested by surviving owners or heirs.
- Without a designated buyer, you or your heirs may be forced to find a buyer quickly and settle for a sale price that is far below fair market value.
Who Needs a Buy-Sell Agreement?
A buy-sell agreement is especially important if you have business partners since it defines both rights and responsibilities of each owner to the continuity of the business. Crafting a buy-sell agreement is an opportunity to consider possibilities – that you may not want to think about, but should – and prepare for how you’d deal with them before you’re in the midst of a crisis or emotionally charged situation.
Even sole proprietors should consider a buy-sell agreement. You may have a long-time employee or even a friend or acquaintance that you’d like to take over the business upon your exit. With a buy-sell agreement in place, you have the peace of knowing that your business will end up in the right hands and your heirs or estate will be fairly compensated. A buy-sell agreement lays out a plan ahead of time to protect the future of your business, specifically:
- It ensures that the right person(s) retain control of the business.
- It specifies when shares of the business can be sold and to whom.
- It specifies a fair price for the business so that other owners and/or heirs are fairly compensated if and when the agreement is triggered.
- Partners also know what they can expect if/when they need to leave the business so it’s a great planning tool.
What should a buy-sell agreement include?
Each agreement will be based on the specifics of the business and the partners so no two will be exactly the same. But there are several basics that should be included.
- Obviously, specify who is included in the agreement and who has voting control if this is applicable.
- List the events that will trigger the agreement to go into effect. Consider the following.
- Conflict among co-owners
- A threat to the business’ integrity because of an owner’s actions
- Voluntary departure of an owner or “cash out”
- Define the structure of the buy-sell agreement, which will determine who buys an outgoing owner’s share and for what price. Consider a variety of options and the pros and cons of each.
- Define the value of the company by having a business valuation performed to determine a fair price for the business or its shares. Business values can fluctuate over months or years, and due to changes within the business or the market. Valuations should be conducted periodically to ensure that the agreement always reflects an accurate value and fair price.
- Specify how the buyout can/will be funded should a trigger event occur. There may be many funding options including cash, loans, life insurance, disability insurance, installment payments, stock options, deferred compensation plans, or a combination.
A buy-sell agreement is one of the most important documents owners of a closely held business will ever sign. It should be crafted early in the life of the business, before complications or potential triggers occur. It’s sometimes an uncomfortable process but owners will breathe easier once it’s in place. Be sure to get the advice of your attorney when crafting this important contract. The expertise of an exit planner is also of great value. Review the agreement every few years to ensure that it reflects the current circumstances of the business and the current wishes of the owners.
I’d welcome the opportunity to help you plan for the potential events that can trigger a buyout, including crafting an agreement to ensure that your business remains in good hands and owners experience the confidence that having a plan in place for the future instills. Contact me for a complimentary review of your situation.