Own a Business with Others? You Need a Buy-Sell Agreement.
Every business with multiple owners needs a buy-sell agreement. A buy-sell agreement outlines what happens if one owner goes through a life-changing event like divorce, death or bankruptcy, or just no longer wishes to be part of the business.
By laying out ahead of time what happens in these situations and how the price for an ownership interest will be determined and paid, owners can avoid costly fights when the unexpected happens.
Working with an attorney ensures that your buy-sell agreement has terms that make sense for the type of business you own and the owners’ specific circumstances.
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What Is a Buy-Sell Agreement?
A buy-sell agreement may also be referred to as a buyout agreement. A buy-sell agreement is like a will for your business. It lets the business owners decide together in advance what events will trigger the requirement that an owner sell his or her interest in the business, and how the ownership interest will be calculated. By agreeing ahead of time, owners reduce the possibility of costly litigation.
What Should Be Included in a Buy-Sell Agreement?
Despite the differences between all businesses, several vital provisions should exist in every buy-sell agreement. These provisions attempt to address potential sources of conflict when the unexpected arises, even when such conflicts seem unlikely.
Triggers in Buy-Sell Agreements
Triggers are events that trigger an owner’s obligation to sell his or her ownership interest in a business. Common triggers include the following:
When an owner passes away, their interest in the business will pass to someone else. Chances are that the heir and the remaining owners never expected to be in a business relationship with one another. The heir may not want the obligation of being a business owner. There may also be multiple heirs, further complicating the situation. By making death a triggering event, a buy-sell agreement can require the business or the remaining owners to buy the deceased owner’s interest from the heir(s).
An owner may unexpectedly become disabled and no longer able to participate in the operations and decision making of the business. By making disability a triggering event ahead of time, owners can require the business or the remaining owners to buy out their interests in the event of future disability.
Texas is a community property state. This means that spouses of business owners may have a community property interest in the business owner’s ownership interest. A buy-sell agreement can prevent legal disputes affecting the business by making divorce an event under which a spouse has to sell their community property interest using a pre-determined method for calculating the price.
An ownership interest in a business is an asset that has to be addressed if an owner winds up filing for bankruptcy. A buy-sell agreement can prevent the business from getting embroiled in an unexpected bankruptcy by requiring the business or the other owners to buy out the bankrupt member at a price based on a pre-determined calculation method.
Situations may also arise in which an owner no longer wants to participate in the business and wants to be bought out. A buy-sell agreement can set forth the circumstances under which an owner will be permitted to exit the company, how the purchase price for the exiting owner’s interest will be calculated, and a plan for paying the purchase price.
Many businesses start with amicable relationships among the owners. Those relationships can fray under pressure from unexpected challenges. Having a buy-sell agreement in place to address unforeseen events can avoid expensive legal disputes by establishing beforehand how those events will be handled and how the price for ownership interests will be determined.
Valuation Methods in Buy-Sell Agreements
One of the greatest sources of contention that can arise among business owners is how to value an ownership interest to determine the purchase price when a triggering event occurs. By agreeing in advance on how the purchase price in a buyout will be set, owners can avoid a common minefield. It is important to work with a business law attorney in choosing a valuation method that makes sense for the type of business you own.
Funding Buyouts under Buy-Sell Agreements
A buy-sell agreement should also contain terms for paying the purchase price for an ownership interest. If coverage is available, the owners may agree to maintain key-man life insurance policies on one another that can enable the business to pay the purchase price in the event of death. The owners may also agree that the business will establish a cash reserve for the purpose of future buyouts. Absent these options, the owners can agree that a purchase price will be paid in installments over a period of time, with or without interest, in an amount that the business is likely to be able to afford.