Buy-sell Agreements

Buy-sell Agreements

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:

  1. Triggering Events – Under what circumstances should the right or obligation to redeem or buy out an equity holder be triggered?
  2. 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)?
  3. 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 pgillin@thklaw.com.

Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon an investigation of specific facts. You should consult an attorney for advice regarding your individual situation.
Developing Buy-Sell Agreements

Developing Buy-Sell Agreements

Developing a buy/sell agreement today can prevent heartache tomorrow.

If you already own or are starting a business with more than one owner, a buy/sell agreement is an important tool that can help protect the health and well-being of your business by spelling out the details of what would happen in the event of an owner’s death, the transfer of ownership of the business or the sale of the business. Taking the time now to create your own buy/sell agreement can reap big savings in time, energy, and emotional strain that could come down the road.

What a buy/sell agreement is and how it can protect your business.

Simply put, a buy/sell agreement is an arrangement between owners of a business through which the surviving owners (or the business entity itself) agree to purchase the interest of a withdrawing or deceased owner. There are many purposes and uses for buy/sell agreements, including:

  • imposing restrictions on the transfer of individual ownership interests in a business entity to maintain a balance of control and prevent participation by third parties who may not be acceptable to existing owners.
  • to serve as an estate planning tool.
  • to lessen the likelihood that internal disputes among the owners will cause irreparable damage to the business or its operations.

While the term buy/sell agreement is sometimes used vary narrowly to refer only to the actual purchase of ownership interests between owners, we recommend that business owners consider having their buy/sell agreement address additional matters. Other issues that may be included in a buy/sell agreement are:

  • management of the business and the owners’ respective roles as officers, directors, managers, and employees of the business.
  • ownership interest transfer restrictions.
  • instructions on what happens to each owner’s interest in the business in the event of his or her death or disability.
  • the involuntary transfer of an owner’s interest (due to a divorce or personal bankruptcy, for example).
  • termination of an owner’s employment.
  • what happens if an owner wishes to voluntarily transfer the ownership interest to a third party (if such voluntary transfers are to be permitted at all).

Management related buy/sell agreement provisions will often also address matters such as:

  • shareholder voting.
  • creation and operation of a board of directors or managers.
  • voting by the board of directors or managers, including voting that selected individuals are elected to particular offices.
  • the establishment of salaries and bonuses.
  • limitations upon powers of directors, managers, officers and owners.
  • tax elections.
  • other matters of particular importance to the owners of the business.

In some cases, confidentiality and non-competition provisions are also included in buy/sell agreements. These provisions can be used to restrict the ability of a selling owner to act in a way that will negatively impact the goodwill and going concern value of the business after the sale of his or her interest. These provisions will often address:

  • general obligations of confidentiality and non-disclosure with regard to proprietary and trade secret information.
  • prohibitions against competition.
  • prohibitions upon the solicitation of employees of the business.

These provisions may be especially critical in situations where one or more business owner(s) has substantial financial strength compared to another, but the less financially secure owner brings the business certain expertise or contacts.

Why you need a buy/sell agreement.

The reason for a buy/sell agreement is simple: at some point in the life of your business one or more of the issues described earlier are going to arise. When that happens you and your fellow owners may not be able to agree on how to proceed. Your relationship with your co-owners may have changed for the worse since the business started or, if one of your co-owners has died, become disabled or suffered a divorce or personal bankruptcy, you may find yourself dealing with a personal representative, guardian, ex-spouse or bankruptcy trustee instead of the co-owner.

By considering these issues now and putting a buy/sell agreement in place you and your fellow owners will have agreed how these issues are to be dealt with. What’s more, you will have made the agreement with the benefit of good relationships and time to reflect on the appropriate balance of your respective interests, rather than being forced in the future to try to resolve issues during a point of crisis or personal distress. Furthermore, you will have documented your agreements in a way that will be binding on not just the current owners, but also on the hypothetical third parties mentioned earlier.

Please note that this overview is intended only as a summary. The drafting of an appropriate buy/sell agreement involves careful consideration and balancing of various potentially conflicting interests of the business and its owners, and each buy/sell agreement should be carefully tailored to the individual facts and circumstances of that business and its owners.

If you have questions about how to get started on developing a buy/sell agreement for your business call Tuesley Hall Konopa at 574.232.3538.

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Eric W. Seigel, Business Counsel, Partner, Tuesley Hall Konopa, LLP

Author: Eric W. Seigel is a business lawyer and partner at Tuesley Hall Konopa, LLP. He helps his business clients with day-to-day business law needs, contract review and negotiation, business acquisitions and sales, and exit and succession planning. He is licensed to practice in Indiana and Michigan.

You can contact Eric by calling 574.232.35378 or by email eseigel@thklaw.com.

Disclaimer: The THK Legal Blog is for informational purposes only and should not be relied upon as legal advice. In no case does the published material constitute an exhaustive legal study, and applicability to a particular situation depends upon investigation of specific facts. You should consult an attorney for advice regarding your individual situation.

Buy-Sell Agreements Video

[vc_row][vc_column][vc_column_text]Buy-Sell Agreements – In this video, Partner and Business Counsel, Eric W. Seigel explains the importance of having Buy-Sell Agreements for your business.

If you already own or are starting a business with more than one owner, a buy-sell agreement is an important tool that can help protect the health and well-being of your business by spelling out the details of what would happen in the event of an owner’s death, the transfer of ownership of the business or the sale of the business.[/vc_column_text][/vc_column][/vc_row]