One of the most important aspects of any business relationship is to have a buy-sell agreement between shareholders that clearly states how significant future changes will affect management and the control of the business. Buy-sell agreements are legally binding contracts between a business and its owners, stipulating what will happen if an event triggers an exchange of shares within the agreement.
Your business may be at risk if you do not have a buy-sell agreement in place. These agreements protect the business and its owners and address potential conflicts that may arise if one or more owners wish to sell their interest in the business or are forced to dispose of their interest, as in the case of the death of a shareholder. While there are many questions that must be addressed when preparing a buy-sell agreement, here are few items to consider:
- What is the nature of the business, and who are the owners and key players?
- How does the buy-sell agreement address continuity of the business operations in the case of a triggering event?
- Does the agreement address issues such as compensation and non-compete upon departure of an owner?
- How will disputes between the owners be settled? Does the agreement compel the principals to use mediation?
- Does the agreement allow an owner to sell to an outside party or restrict the sale of stock?
- What events will trigger the buy-sell agreement? Common trigger events include death, disability, and retirement, but other events such as termination of employment, dissolution of a marriage, bankruptcy or insolvency, disputes among owners, or termination of employment should be considered as well.
- How will the value of the business be determined? Is there a prescribed formula or is it reliant upon an outside party?
- How will buyout of one’s interest be funded and what are the terms of the payout – is there a down payment, interest, and collateral?
- If insurance is needed, will it be term or whole life? Who will own the policy and who will be the beneficiary?
- What is the tax impact to the business and the individuals?
- If the business is an S corporation, does the agreement contain provisions to ensure the company will not violate its S corporation status?
In addition to the consideration given to the above, there are some general do’s and don’ts of buy-sell agreements:
- Identify and decide on short- and long-term objectives that make sense for the business and the individual parties involved. It is better to understand in the beginning whether the parties involved share the same objectives and vision.
- The parties involved should reach an agreement on the terms before having documents drafted.
- Consider the tax issues. Tax planning can save the parties involved a significant amount of money in the event shares are exchanged.
- Make sure proper consideration is given to worst-case scenarios to protect against instances when relationships sour and the parties involved may not get along.
There are a host of items to consider in crafting a well-designed buy-sell agreement that meets the needs of all the owners and that puts the business in a position to continue operations without creating a financial hardship when a triggering event occurs. If your business does not have a buy-sell agreement, the owners should consider this a high priority.
Businesses that have buy-sell agreements in place should consider reviewing their agreement periodically to ensure that it continues to meet the needs of the business and owners. The time and effort you devote to your buy-sell agreement today will be well worth it in the future when it is needed.