by Morris R. Saunders
What is a “buy-sell agreement”? It is an agreement in which co-owners of a business provide opportunities for the business to continue even after certain events may occur to one or more of the owners. Who needs a buy-sell agreement? If a business has more than one owner, then it is appropriate that a buy-sell agreement be in place.
In closely held businesses, the owners are generally required to work together in the business and are often the key employees. Without the contribution of all of the owners, the business could be faced with challenges to survive. If one owner dies, who would own his or her interest in the business? Would the owner’s successor be capable of working in the business? Would the surviving owners be able to work with the new owner? What would happen to the business if one owner went through a contentious divorce in which the court ordered half of the owner’s interest in the business be transferred to the owner’s ex-spouse? Suppose an owner became disabled and could no longer contribute to the business? Should the business be required to continue to pay that owner a share of the profits? Should the disabled owner receive compensation while he or she is unable to work? What constitutes a “disability”? What would happen if an owner wanted to sell or transfer his or her interests to a family member, a third party or even a competitor? Would the other owners desire to work with a new owner? What if an owner wanted to retire, or withdraw, from the business? Should that owner continue to own interests in the business or should he or she be required to sell the interests to the other owners or to the business?
A buy-sell agreement could address the issues presented above by the occurrence of certain events (often referred to as transfer events or triggering events) and help provide the business with a chance to succeed even after the occurrence of unanticipated events. Buy-sell agreements are often a part of a shareholders agreement, a limited liability company operating agreement and a partnership agreement. It may even be appropriate for a sole proprietor to have an agreement similar to a buy-sell agreement with a key employee so that the owner has some exit strategy.
A buy-sell agreement often gives owners the option to purchase the interests of the other owners upon the occurrence of certain “triggering” events, such as divorce, death, disability and bankruptcy. Upon the occurrence of these events, absent proper planning, the ownership of the business could be transferred to parties who have no involvement in or familiarity of the business. This could have a very serious negative effect on the business. If the remaining owners have the option to purchase the affected owner’s interests, then they will be in a better position to continue to operate the business as they desire. Most options give the remaining owners or the business a reasonable time to decide whether to purchase the affected owner’s interests. Some agreements provide for the mandatory purchase of a decedent of disabled owner’s interests. Some agreements also provide for a mandatory purchase if the owner retires after a certain amount of time or upon reaching a certain age.
A buy-sell agreement also provides owners with a right of first refusal to purchase the interests of an owner who desires to voluntarily transfer his or her interests to a third party. The right of first refusal could give the other owners or the business the right to “match” the offer of the third party or could give them the right to purchase the interests based upon the terms of the agreement.
When individuals get together with other individuals to form a business, they choose who they want their co-owners to be. Without proper planning, certain common, everyday circumstances can occur which could result in unwanted co-owners. If this occurs, the continued viability of the business could be threatened. Proper planning gives the co-owners the ability to continue to choose their co-owners and gives the business the best chance to continue to succeed. In the case of a sole proprietor, it may give the owner a good exit strategy and give the business a chance to continue after the proprietor is no longer involved in the business.
In the future additions of the LawGram®, we will discuss methods of valuing the closely held business for purposes of determining the purchase price payable as a result of an exercise of an option or right of first refusal, whether it is appropriate that the other owners or the business be the purchaser, methods of funding the purchase price and methods of structuring and securing the payment of the purchase price.