Most owners start thinking about a sale when a buyer appears. The preparation that protects…
Do You Need A Buy-Sell Agreement for Your Business?
There are many unexpected changes that can cause an otherwise successful business to suddenly change direction. A buy-sell agreement can help business owners prepare for events such as death, disability, divorce, retirement or disputes between owners. Speaking with a business law attorney can also help you identify potential issues before they arise.
What Is a Buy-Sell Agreement?
A buy-sell agreement is a legally binding agreement between the owners of a business. It establishes what happens when an owner leaves the business or another specified triggering event occurs.
Think of it as a succession plan for your business. Instead of leaving important ownership questions unresolved, the agreement allows the owners to decide in advance how certain transitions should work. A buy-sell agreement can therefore form an important part of business succession planning.
The terms of a buy-sell agreement should reflect the business structure, the owners’ goals, the existing governing documents and applicable law.
What Should a Buy-Sell Agreement Include?
A buy-sell agreement should address the issues that could affect ownership and management if circumstances change. Taking the time to discuss these questions with your other business owners and business attorney can help you prepare for transitions and support the continued success of the business.
Ownership and Management
- Are there any non-owners on the management team?
- Do all owners participate in the management of the business?
- Are procedures in place to manage ownership or leadership transitions?
- Have key employees been identified other than the owners?
- Do any key employees have stock options, profit interests or another instrument that can convert to equity?
- Could the business face a deadlock, such as a 50/50 ownership split? If so, is there a mechanism for resolving the deadlock?
If you are unsure how your business formation and dissolution documents affect ownership arrangements, consider having them reviewed by an attorney.
Triggering Events
A buy-sell agreement should identify the events that could trigger an ownership transfer or buyout. Common examples include:
| Triggering Event | What the Agreement Can Address |
|---|---|
| Death | Who can purchase the deceased owner’s interest and how the purchase will be funded. |
| Disability | When a disability triggers a buyout and how the owner’s interest will be handled. |
| Retirement | How an owner’s interest will be valued and transferred when the owner retires. |
| Bankruptcy | Restrictions or procedures that apply if an owner’s financial circumstances affect their business interest. |
| Termination of employment | Whether leaving the business also affects the owner’s ownership interest. |
| Sale to a non-owner | Whether existing owners have a right to purchase the interest before it goes to a third party. |
| Divorce | How the agreement addresses potential ownership issues arising from an owner’s divorce. |
| Expulsion of an owner | Whether and how an owner’s interest can be purchased following an agreed triggering event. |
Buyout and Valuation Terms
If a triggering event occurs, what buyout options will the remaining owners have?
The agreement should also establish how the business or ownership interest will be valued. Depending on the circumstances, the owners may consider a valuation formula, an independent appraisal or a predetermined price.
The agreement should also address how payment will be made to the departing owner. For example, the owners may need to establish whether the purchase price will be paid immediately, over time or through another agreed funding arrangement.
Funding the Buyout
Life insurance may help fund a buyout following the death of an owner. If the owners plan to use life insurance, the agreement should address important questions such as who will own the policy and who will receive the proceeds.
The owners should also review the potential tax consequences of a buyout with their legal and tax advisers. The tax treatment can depend on the business structure and the type of transaction. For example, the IRS treats the sale of business assets differently from the sale of a partnership interest or corporate stock. The IRS provides additional information about the federal tax treatment of business sales.
Other Ownership Considerations
Depending on the type of business, a buy-sell agreement may also need to address:
- Professional licensing requirements that could affect a transfer of ownership.
- Restrictions on transferring ownership interests.
- Whether the owners want to restrict the issuance of new equity.
- Whether minority owners should receive protection if a majority owner decides to sell to a third party.
Key Considerations for a Buy-Sell Agreement
Before creating or updating a buy-sell agreement, consider the following:
- The type of business you have.
- Whether you already have a buy-sell agreement in place.
- The people who manage the business.
- How the owners address employment issues such as:
- Compensation.
- Non-competition agreements.
- Non-disclosure agreements.
- Non-solicitation agreements.
- Protection of intellectual property and other intangible assets.
These issues can overlap with other agreements and contracts used by the business. Reviewing the documents together can help ensure that the terms do not create unnecessary conflicts or uncertainty.
How to Prepare a Buy-Sell Agreement
Start by going through the questions above with the other business owners. Consider what should happen if an owner dies, becomes disabled, retires, leaves the business or wants to sell their interest.
Then review how the business will value the departing owner’s interest, who can purchase it and how the purchase will be funded.
If you are unsure about the answers or how a particular provision could affect your business, speak with a business attorney before making changes to your ownership documents.
Plan Ahead for Changes in Business Ownership
A buy-sell agreement gives business owners an opportunity to address difficult ownership questions before an unexpected event occurs. The right terms will depend on your business structure, ownership arrangements, goals and applicable law.
Littleton Legal can review your existing business documents, help you identify potential gaps and discuss whether you need a new or updated buy-sell agreement.
Ready to protect your business from unexpected ownership changes? Contact Littleton Legal to discuss your business succession and ownership planning needs.
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