Posted on: June 28th, 2016
We never really know when a business venture will come to an end. People change, circumstances change and because of this, business owners should know about buy-sell agreements and why they are crucial to the ongoing management and control of a business.
What Is A Buy-Sell Agreement?
A buy-sell agreement is an agreement between business owners that clearly outlines what will happen to their interest in the business if an event like death, divorce, disability or disagreement occurs. It is a document that business owners should put in place early in the life of the company and periodically revisit as the company continues to grow.
Why Have A Buy-Sell Agreement?
A buy-sell agreement facilitates the orderly transfer of business interests when certain specified events occur. A buy-sell agreement:
Maintains continuity of the business by providing a smooth transition of management that is acceptable to all owners
Prevents outsiders from obtaining control by restricting the transferability of a business interest
Provides orderly liquidation on departing owner’s interest
Minimizes litigation (and the cost and time associated with it)
What Should Be Included In A Buy-Sell Agreement?
A buy-sell agreement should address what triggers a buy-out, the method for determining the value of the business interest, and how the buy-out will be funded.
Triggering Events
Some of the most common triggering events include:
Death. The death of an owner almost always triggers the obligation to purchase the departing owner’s interest by the business or surviving business owners.
Disability. The disability of an owner who has been active in the business may trigger a buy-out.
Divorce. The owners of a business may not want to be in business with a former spouse of a divorcing owner and their divorce by trigger a buy-out.
Disagreement. If business owners can no longer agree on the direction of the business, a disagreement amongst the owners may trigger a buy-out.
Method For Determining The Value
A buy-sell agreement should provide a method for valuing the interest of the departing owner. Typically, the services of a certified public accountant (CPA) or business valuation professional are needed to assist in determining the appropriate method. Some of the most common approaches include an agreed upon value, appraisal and/or valuation formula.
Funding The Buy-out
The buy-sell agreement should provide how the buy-out will be funded. Some of the common methods include cash, borrowing, installment loans and purchasing insurance. While each has its advantages and disadvantages, special consideration should be taken into account when reviewing the funding method. Business owners should consider whether or not the remaining business owners will be able to obtain credit to fund the buy-out or if the departing business owner wants to rely on the remaining business owners to make payments over time.
Avoid The Ugly Break-up
The time for business owners to have the buy-sell agreement discussion is when things are going well, to avoid an ugly “break-up” situation. With careful planning alongside a qualified team consisting of a business attorney and an accountant or business valuation expert, a buy-sell agreement can ensure that a business continues to operate successfully despite a falling out between business owners or other triggering events.