Buy-Sell Agreements are contractual commitments between co-owners of a business entity pertaining to the sale of their ownership interests upon the occurrence of certain pre-defined events. Having such an agreement in place provides stability to the underlying entity, liquidity, and assurance to the owners. These types of agreements can be very complex and should be tailored specifically for the particular circumstances of the entity and its owners. However, there are some common considerations that should be evaluated in any buy-sell agreement.
A buy-sell agreement should have so-called “trigger events”. These are the happenings that will initiate an option or obligation to buy and sell. Common trigger events include the death of the owner, involuntary transfers of an owner’s interest (e.g. those arising in divorce, death of the owner’s spouse, or bankruptcy), disability of the owner, termination of the owner’s employment with the entity, and disability of the owner. In addition, if an owner receives a third party offer to purchase his interest, it is common for the entity itself and/or the other owners to have right of first refusal to purchase the interest upon the terms offered by the third party.
For any of these trigger events you will need to consider whether the event creates an option or an obligation to buy and sell and it need not be the same for all events. For example, it is generally desirous for liquidity and business continuity purposes for the death of an owner to create an obligation to purchase and sell the deceased owner’s interest. By contrast, if an owner resigns from his employment, it may only warrant an option to purchase the departing owner’s interest.
For any trigger event you also need to consider whether the option or obligation to purchase the interest will belong to the business entity itself or to each of the other owners. We frequently answer this question by assigning the right or obligation to purchase first with the business entity and then to the other owners to the extent that the business entity does not or cannot purchase the interest.
Maybe the hardest decision to make is how to determine the purchase price for the interest. What makes sense for one business may not make sense for another. For some businesses the owners may wish to use a formula or rule of thumb such as a multiple of earnings. For others a balance sheet based valuation may make sense. In other cases, if the owners have a value in mind and they are diligent about updating it, they can periodically (e.g. annually) set and reset the purchase price. In the absence of alternatives, the owners may defer the decision of computing the business’ value to an independent appraiser.
Once the business’ value is established you also have to consider how it will be paid. A relatively steep purchase price may require funding over time. Death buy outs can also be funded entirely or partially with life insurance.
If you can work through these issues you have made the major decisions that will impact what your buy-sell agreement looks like. Careful consideration of these issues and their alternatives should be made in conjunction with your legal counsel. Webb & Webb’s business attorneys have extensive experience in advising business owners in matters pertaining to buy-sell agreements. Please let us know if we can be of assistance.