Buy-sell Agreements: Prenups for Closely-held Businesses
You and a friend have taken the plunge, pooled some money together, and bought a business. You have retained the deciding vote on day-to-day decisions concerning the business, but you need your buddy’s okay before making major decisions. You both see eye-to-eye on how to run the business and you don’t foresee that ever-changing. You are ready to get after it and make some money but have a nagging feeling that you are forgetting something important.
To borrow a sentiment from Tom Cruise in Top Gun, what happens if you and your buddy lose that loving feeling? Fast forward three years to a time when you and your friend no longer see eye-to-eye on where the business is headed or how best to get the business there. Your buddy is tired of humping it for 80 hours per week to continue to grow the business and neither of you can agree on whether to risk additional capital to try to grow the business further. You are at an impasse stuck between trying to recapture the shared vision of success you once held and throwing in the towel. If only you could find a way to break the impasse and get on with running the business. Negotiating the redemption or buyout of a partner under these circumstances can be challenging due to the emotional baggage that tends to build up over time.
A buy-sell agreement is like a prenup for a closely-held business. By taking time at the outset of the partnership when the principals are singing from the same song sheet, the principals can identify situations where either the business or one or the other principal should have the right to buy a partner out of the business. And they can agree in advance on a mechanism for establishing a fair price at which such a buyout would occur. Knowing that there is an exit plan available should partners reach an impasse and that the exit plan will treat each of the partners fairly if the time comes will relieve much of the tension that could otherwise build up among business partners as their respective visions for the future of the business or their desired participation in it diverges.
Key issues to consider when discussing whether a buy-sell agreement is right for your business include:
- Triggering Events – Under what circumstances should the right or obligation to redeem or buy out an equity holder be triggered?
- Pricing – What is a fair and efficient way to establish the value of an equity holder’s interest in the business (taking into account that the value of the business is likely to change over time)?
- Funding – An agreement to redeem or buyout an equity holder is only valuable to that equity holder if there is a means to pay him for his interest in the business. Careful thought should be given to how to assure that adequate funds will be available to make good on that part of the bargain.
Author: Pete Gillin is a seasoned transactions attorney whose experience includes advising middle-market and closely-held businesses. Practice areas include business counsel, business formation, business transactions, business acquisitions, succession planning, partnership agreements, financing agreements, contract review, and intellectual property matters.
You can contact Pete by calling 574.232.3538 or email firstname.lastname@example.org.