Any business that has multiple owners and isn’t publicly traded needs a Buy/Sell Agreement. With large private companies with lots of owners/partners/shareholders, there is usually a routine way that parties come and go. Think of the large accounting or consulting companies with hundreds or thousands of partners.
But with smaller companies with only a few owners, it is surprisingly common for no Buy/Sell to be in place. This can cause terrible problems upon death, disability, divorce or other life event that forces the sale of one or more owners’ interests.
Buy/Sell Agreements are also known as Buyout Agreements and are often thought of as a business pre-nuptial agreement or business will. It is best to lay out the terms of buying/selling before the circumstances arise. The beauty of Buy/Sell Agreements is that they are reciprocal because it isn’t clear who is going to be the buyer and who is going to be the seller. What is usually clear is that no one wants the heir of an owner to become involved in the management of the business.
Types
There are two main types of Buy/Sell Agreements. First is a Cross Purchase plan where the remaining owners buy the ownership share of the departing owner. The second, and actually more common type, is a Repurchase Plan. In this case the company buys the ownership interest from the departing shareholder.
Less common are Put Options (the right to sell upon exercise), Right of First Refusal and Right of Consent. All forms will address who can buy the ownership interest, perhaps even outsiders.
Circumstances
There are several events that need to be anticipated as far as the trigger for a Buy/Sell Agreement to become operable. First is death, which is objective but, well, they’re dead. Disability is tougher to define or objectively measure. In addition, if a person is disabled, how does that affect any guarantees they have made? Divorce is the third of the Dreaded Ds and requires special care in community property states, such as Washington.
Other reasons for triggering a Buy/Sell are retirement, relocation, personal bankruptcy or maybe the owner just wants to leave. Personal bankruptcy is another one that requires special care since the bankruptcy trustee can potentially go after the ownership interest in the business and could impair the entire enterprise.
Price
Determining the value of the ownership interest is tricky and dependent on many circumstances. The Buy/Sell Agreement could call for an appraisal to determine fair market value. Or the amount can be negotiated at the point the Buy/Sell is triggered, but that means the buyer and seller are usually clear and the neutrality of the Buy/Sell has been lost. Often a formula is agreed to and placed in the Buy/Sell Agreement so there is no negotiation on the price. Formulas vary but can be based on Net Income, EBITDA, Revenues, Cash Flow, Book Value or almost any other measure that can be imagined. Discounts to the value are often made for lack of marketability and/or minority interest.
What is perhaps most difficult is that the value is often dependent on circumstances. For example, if there are few owners then much of the value is lost when a key owner dies, is disabled or retires. If the departing owner was the firm’s rainmaker, the business left behind may have very little value.
Sometime there is no value if an owner leaves to work for a competitor and another value is used for death, disability or retirement.
Keep in mind that the owners can negotiate anything they want when the time comes. If all agree, fine. If there isn’t agreement, the Buy/Sell Agreement is what governs.
Financing
Once a Buy/Sell Agreement is put in place, we’re halfway there. The other half is paying for it. The most common arrangement is to have the company buy term life insurance for every owner covered by the Buy/Sell with the company as the beneficiary. The life insurance proceeds provide the funding mechanism for buying out the ownership interest from the estate. This maintains control within the group and provides liquidity in the estate of the departed.
The estate can also take back a note, that is, receive the purchase price over time in an installment sale. The banks, with and without SBA involvement, will also finance the purchase of ownership interests.
Other Issues
Other issues to consider include the relative salaries of those covered by the Buy/Sell Agreement, non-Competition Agreements and whether the business owner will devote full or part-time to the business. Finally, the Buy/Sell Agreement can be part of the governing documents of the business entity or can be a separate document.
Does this sound like a lot of complexity? It isn’t as bad as it sounds. Between a good business lawyer and your financial advisor, all the right questions for your circumstances can be answered and you’ll make life a lot easier in your future.
(Thanks to Bob Sailer of Pacific Northwest Law Group in Redmond for his review and helpful suggestions for this article.)
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