Do I really need a buy-sell agreement for my business? We get asked this all the time. Technically, no, you do not need a buy-sell agreement to operate your business; but you should certainly consider it. Without a thorough buy-sell agreement, your business is at risk.
What is a Buy-Sell Agreement?
A buy-sell agreement is a legal document between the company and its owners that specifies how a significant event (such as divorce, death, disability or resignation) will affect the control of the company.
In it’s most basic form, the purpose of a buy-sell agreement is to specify how an individual’s ownership interest in the business will be transferred if that person will no longer be part of the company. This will happen in one of two ways: (1) an owner decides he wants to leave the company for any reason, whether retirement or to pursue employment elsewhere, or (2) an owner passes away.
A thorough agreement will address the needs of the owners, and any potential conflicts that may arise in the future if a partner passes away, gets divorced, or wants to sell their interest in the company.
Your buy-sell agreement should address:
- Under what circumstances an owner’s interest may be transferred;
- Whether the business or its remaining owners have the right to purchase the interest from the departing owner;
- How that owner’s interest will be valued; and
- In the event the remaining owners or the business do not buy the interest, who can be accepted as a buyer of the ownership.
Who Gets My Partner’s Ownership Interest If They Leave?
If your partner wants to leave the business or passes away, you want to be able to control who gets his/her ownership interest. You certainly don’t want your partner to be able to sell their interest to someone else of whom you don’t approve. The buy-sell agreement can dictate the people or entities to which the ownership interest can be sold.
How Much is the Ownership Worth?
This is a tricky question, but one that a well drafted buy-sell agreement will answer for you. There are a few ways you can value the departing owner’s interest. The first method is the appraisal approach. If your agreement simply says “an appraisal will occur”, you’re in for a headache if/when your buy-sale agreement is triggered. This is a boilerplate term that is not helpful to you at all. Essentially, you’re agreeing that some professional will appraise the business and determine the ownership interest’s value. Appraisal’s can be expensive and can lead to a conflict of who pays the appraisal cost. It’s also problematic because the departing owner or remaining owner may disagree with the appraiser’s valuation.
Another option is to have an experienced business broker appraise your company, but you will likely have the same appraisal issues as in the first option. This is why the best method is generally to include a specific formation for how the interest’s value will be calculated.
Because the formula is agreed to by all parties during the drafting of the buy-sell agreement, it eliminates the concern that someone will disagree with the valuation. Regardless of which option you decide is best, you will need to ensure that an insurance policy is in place to fund the buy-sell agreement.
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