When entrepreneurs agree to go into business together, they are typically excited about the prospects of their mutual business relationship and very amicable upon the onset of the endeavor. However, at some point in the future one or more owners will inevitably depart from the business. By having a properly structured buy-sell agreement, the owners will be able to ensure a smooth and orderly transfer of ownership interests.
Why Have a Buy-Sell Agreement?
First and foremost, a buy-sell agreement will document the best way to transfer ownership while all of the owners are still engaged and active in the business. If you wait too long, individuals will be influenced by their own paradigm and personal situation.
In addition, a properly structured buy-sell agreement will address ownership transfers for unanticipated business departures, which are commonly referred to as the 5 D’s – death, disability, distress, divorce, and disagreement.
- Death. It should be clear what will happen to the ownership interest upon the unfortunate death of a business partner. The remaining owners will likely not want to be business partners with the spouse or the estate’s heirs.
- Disability. What happens if someone is no longer able to work? In many cases, business owners are required to be actively working to be an owner. The buy-sell agreement should spell out what will happen if an owner is no longer able to work due to injury or illness.
- Distress. Similar to disability, an owner may not be able to work due to a difficult personal situation (e.g., taking care of a sick loved one) and it is important to include provisions that will protect the company and the owner in this type of circumstance.
- Divorce. This consideration applies directly to businesses that are owned by a married couple. A successful business should not be harmed in the event a marriage ends.
- Disagreement. It is not entirely out of the question that business partners may someday no longer want to be in business together. In these unfortunate circumstances, a buy-sell agreement is instrumental in maintaining an orderly departure while emotions are typically riding high.
Each of the D’s above is geared to protect the many individuals who are impacted by an ownership interest within a privately held business. For example, the widow(er) of an owner needs to be protected in the event of a death. Likewise, the remaining owners need assurance that the ownership can be redeemed by the business.
What Types of Businesses Should have a Buy-Sell Agreement?
Essentially, any business with more than one owner needs a buy-sell agreement. It does not matter if the business is a corporation, partnership, or LLC. As long as there are multiple owners it is appropriate to ensure that a buy-sell agreement is in place. Even businesses which are entirely family owned should have such agreements; without one, family relationships can be damaged due to a lack of clarity in ownership transitions.
What Should a Buy-Sell Agreement Include?
A basic buy-sell agreement should include the following items:
- A reliable process for how ownership can be transferred
- Who does and does not have the right to buy an ownership stake
- How to value the ownership interest for a departing owner or for estate tax purposes
- What happens to the ownership interest in the event an owner passes away
- How ownership redemptions are financed or paid for
- Provisions to remove owners under certain circumstances
- May also include various other governance provisions to ensure business continuity
Depending on the type of entity, the provisions of a typical buy-sell agreement may be included or take form in a different document. For example, a partnership may include such provisions within its partnership agreement, and the same may be true with a shareholder agreement for a corporate entity. Nevertheless, it is critical to check these agreements to ensure that buy-sell provisions are in place.
Regardless of the form a buy-sell agreement takes, it is prudent to regularly review the agreement and ensure that it is up-to-date. As businesses grow and evolve, it is not uncommon for buy-sell agreements to need amendments from time to time. If you need assistance with reviewing, updating, or creating your buy-sell agreement, please contact us.