In business, change is inevitable. This is especially true for businesses that involve multiple interest- holders, each with his or her ownership interests, business responsibilities, and personal lives. For this reason, it’s important for companies to prepare for the unexpected and enter into what’s known as a Buy-Sell Agreement with their partners or shareholders.
A Buy-Sell Agreement provides exactly how (and for how much) a transfer of ownership interest in a business takes place upon the occurrence of certain events. Without this protection in place, a departing or deceased partner’s interest will transfer to a spouse, heir or buyer who may have little to no experience in running a business. To avoid putting any decision-making power in inexperienced hands, and to mitigate potentially upsetting the company’s success and profitability, an effective Buy-Sell Agreement will include detailed instructions and protocols regarding the following business concerns:
The most important thing to consider in drafting a buy-sell agreement is the list of events that will trigger its provisions. The most obvious event is the death of a partner, but a Buy-Sell Agreement can be made to take effect upon a partner’s disability or incapacity, bankruptcy, departure from the company, or divorce from a spouse. It’s important to make these trigger events clear and unambiguous so that there is no confusion as to when the Buy-Sell Agreement will come into play.
Once a triggering event occurs, a Buy-Sell Agreement should specify how a partner’s interests are sold or transferred. Many Buy-Sell Agreements prevent the transfer of a partner’s ownership interests to spouses or heirs until the company (or its shareholders) have had the opportunity to purchase the shares. Under these provisions, the ownership interests will only pass on to the partner’s spouse or heirs once the company or shareholders have made clear that they are unable or unwilling to make the purchase. To prevent this period of deliberation from becoming indefinite, it’s best to include a clear time-line during which the company will have the option to make the purchase.
After the buy-sell agreement determines who can buy a departing partner’s share of the business, it should determine how much of that interest can be purchased. In the case of death or incapacity, for example, the company would likely seek to repurchase the entirety of the departing partner’s interests so that the business can resume operation as smoothly as possible. On the other hand, where a partner is involved in a marital divorce, the company would likely prefer only to repurchase those interests that actually transferred to the partner’s spouse, so as to avoid diluting the partner’s interests.
Valuation method is also incredibly important to an accurate sale or transfer, and specifying how the company will be valued at the time of a buy-sell event will save you a headache and disagreements later on.
These issues are ones that are best avoided at the eleventh hour. Buy-Sell Agreements are critical to protecting a business, its partners, and their interests, and should be drafted by an experienced attorney and updated regularly to ensure that they continue to reflect the desires of the business owners.