Buy-Sell Agreement – Or – What Can Happen to Your Small Business When One Of Your Partners Leaves?

Friends

Starting a small business of your own can be a truly exhilarating experience.  In the excitement of watching your dreams come to light right before your eyes, you may very well overlook one of the most important contracts you need to have in hand when you start your small business (if you have one or more partners) – the buy-sell agreement between co-owners.

Simply put, every closely held company, whether a corporation or limited liability company with more than one owner, shareholder or member,  needs a buy-sell agreement in place.  The buy-sell agreement will spell out what happens if one of the co-owners dies, becomes disabled or leaves the business.  Operating agreements or partnership agreements sometimes address these issues provided they were prudently drafted.  Unfortunately, that is often not the case.

If your small business is owned by more than one person, the shareholders should have an agreement known as a “shareholders agreement”.  This agreement can serve many functions and usually addresses sales to third parties, voting requirements, who serves as officers or on the board of directors, dispute resolution, non-compete provisions, etc.

The essence of most buy-sell agreements, however, is the right or obligation of one shareholder to buy the shares of another shareholder if or when certain triggering events occur.  Death, disability, retirement and employee termination (remember, shareholders are employees of their corporation) are all events that a buy-sell agreement might address.  Each company will have its own way of approaching the situation and the approaches are usually based on the event or the shareholder affected by the event.

Buy-sell agreements can provide for purchases by the company.  Some agreements give the company options to purchase and others give the affected shareholder the option of offering his or her shares to the company.   And in some cases, the spouse of a deceased shareholder can succeed to the shares and in others the estate of a deceased shareholder must sell his or her share back to the company or the other shareholders.

We could talk about the possibilities forever but the following are the chief issues to think about when having your attorney draft a buy-sell agreement:

What events will trigger the purchase of a shareholder’s shares?  Any event which would cause the shareholders to want to reconsider their arrangement.  Death and disability are probably the most common. Buy-sell agreements can also cover situations where shareholders are employees and their employment with the company is terminated, for whatever reason.

Who buys the shares?  Once a triggering event occurs, the company must decide what it wants to do with the affected party’s shares.  Mandatory purchases, mandatory sales, options to purchase and options to sell are all options.   Purchases can be made by the company itself or by the other shareholders.

How much are the shares worth?  Standard buy-sell agreements establish procedures for valuing the company and arriving at a fair purchase price.  This can be done with the assistance of the company’s accountant and attorney.  If this is handled properly, it can fix the company value for IRS purposes – a serious issue for family owned businesses.

How is the purchase price paid?  When you have the price established, the next issue is to determine how the price will be paid.  Sometimes the purchase price is funded through life insurance proceeds or disability policies.  Often, an initial payment is made as a down payment on the purchase price with the balance of the price being paid over a specific period of time.  It is usually better not to subject the company to a large lump sum payout.

Shareholder agreements are among the most critical, and often overlooked, documents in a small business’ files.  They do not need to be extraordinarily complex but they do take some time and expertise to craft properly to make sure that the proper contingencies are covered.  Taking the time to address these issues appropriately when the company is founded is imperative to avoid leaving one’s heirs and surviving shareholders with a contentious mess in the event of a death or other unanticipated event that changes the shareholder makeup of the company.

Do you have a plan in place for your business?

Creative Commons License photo credit: jocki84

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Written by Integrated General Counsel

Our focus includes handling a variety of corporate matters and also includes litigation in state and federal courts. Our current practice includes providing transactional services and representing a variety of small and medium-sized companies as their outsourced general counsel.