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Do You and Your Partners Have a Buy-Sell Agreement?

Do you have partners in your business? If so, do you have a buy-sell agreement between the partners that will address what will happen to the ownership of the business if certain events occur? Do you need a buy-sell agreement if the business is only owned by family members?
You may believe that since all the owners of the business are family members that you do not need a buy-sell agreement. That’s not the case. For example, consider the hypothetical case of Ralph Jones who is President of Jones Manufacturing and a widower. is daughter and son-in-law also work in the business. Ralph married Gloria, who then asked Ralph to take her son, Claude, into the business. But Ralph refused. Several months later, Gloria filed for divorce and Ralph was ordered not to dispose of his company’s assets. Then, Ralph had a fatal heart attack leaving Gloria to inherit a substantial portion of the company’s stock. The story doesn’t end there. Gloria sold her shares to a competitor who squeezed Ralph’s daughter and son-in-law out of the company.
Every business that has more than one owner, whether the owners are related or not, needs a buy-sell agreement. A proper buy-sell agreement can assure that the business remains in the family. Without such an agreement, family members could transfer their ownership interest to outsiders or, in the event of a bitter divorce, the ex-spouse could become an owner. There are other reasons the business should have a buy-sell agreement.
A properly drafted buy-sell agreement addresses various issues, such as:

  • What rights will the other owners have if certain events occur with respect to an owner?
    • Death?
    • Disability?
    • Retirement?
    • Divorce?
    • Creditor problems?
  • What rights will the other owners have if one owner desires to sell or transfer ownership of the shares to a third party or to a family member?
  • What will be the purchase price for equity if the remaining owners are entitled to purchase shares from one or more of the owners due to an event as described above? How will the business be valued?
    • Book value?
    • EBITDA (Earnings Before Interest, Tax, Depreciation and Amortization)?
    • Gross revenues?
    • Agreed value?
    • Other formulas?
  • How will the purchase price be paid?
    • Lump sum?
    • Installments?
    • If installments, what is the security for the payments?
  • Which owners will be entitled to participate in the management of the business?
  • Will all owners be employed in the business?
  • What decisions for the business require a majority vote of the owners? What decisions require more than a majority vote?
    • Loans?
    • Sales of assets out of the ordinary course?
    • Issuance of additional equity?
    • Capital expenditures in excess of a prescribed threshold?
  • Who will purchase the equity from a departing owner?
    • The business?
    • The other owners?
  • How will the purchase price for equity be funded? Life insurance? Are all the owners insurable?
  • Will the owners be bound by non-competition provisions? Non-solicitation provisions? Confidentiality provisions?

These and other important questions can be addressed in a buy-sell agreement which can minimize conflict among business owners should a serious event occur.