“Whether the business is a corporation, limited liability company or partnership, one of the most important things owners in a new company can do is enter into a buy-sell agreement.”
Do You Have Your Buy-Sell Agreement In Place?
When starting a new business, owners, rightfully so, are focused on getting operations up and running and making the business profitable. If there is more than one owner, everyone is usually in a “honeymoon” period where everyone is getting along and everyone believes that the business will last forever.
Because of this, the best time to plan for long-term ownership and management issues is when the company is fairly new and everyone is getting along. Whether the business is a corporation, limited liability company or partnership, one of the most important things owners in a new company can do is enter into a buy-sell agreement. With a properly drafted buy-sell agreement, business owners can:
- Avoid complex negotiations and or litigation when an unforeseen event occurs (such as the death of an owner);
- Preserve control for the existing owners;
- Facilitate succession planning for the owners; and
- Avoid disruptions in management.
Typically, when business partners start a new business, they intend to go into business and stay in business with their business partners, not their business partners’ spouses, children, friends or worse, creditors. A buy-sell agreement can restrict an owner’s ability to transfer his/her equity interest in the company. Additionally, the buy-sell agreement can also provide for what happens to an owner’s equity interest in the company upon the occurrence of certain “triggering events”, which typically include the:
- Retirement of an owner, or Divorce of an owner or when an owner ceases to be actively involved in the company.
Upon such a “triggering event,” the buy-sell agreement can allow (or require) the Company to repurchase the equity interest of said owner - a concept known as “redemption”. Alternatively, the buy-sell agreement can grant such an option (or obligation) directly to the other owners of the company – a concept known as “cross-purchase.”
The agreement should clearly state how to determine the value of the company and the equity interest to be purchased and should provide one of the following methodologies for determining the purchase price:
- A price mutually agreed upon by the owners, provided that the price is revisited (typically annually) to make sure it remains fair and consistent with the ever-changing value of the company;
- Setting a formula, such as a multiple of Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA), at the time of the “triggering event”; or
- The appraised value of the company as determined by independent appraisers at the time of purchase of the selling owner’s equity interest.
To ease the burden, a company may purchase disability insurance on its owners for the purpose of funding the purchase of the owner’s equity interest in the company in the event of his/her death or disability.
Having an effective buy-sell agreement in place can allow for a smoother transition during an otherwise difficult time. It also ensures that ownership will remain with the individuals who were always intended to be the owners. There can be a lot of risk and uncertainty in starting and operating a business. It is unnecessary to increase this risk and uncertainty by not having a clearly articulated buy-sell agreement right from the start.
If you have any questions regarding buy-sell agreements, please contact Darrin S. Baim or Richard M. Wallace.