Buy-Sell Agreement Is Vital To a Strategically Planned Business Arrangement
Having a Buy-Sell Agreement Is Vital To a Strategically Planned Business Arrangement
By Ken Bloom, J.D., LLM & Jonathan Goldberg, J.D., CPA
A recent television commercial for a large investment firm shows a business owner talking about how his life changed drastically when his business partner of 27 years passed away, and now he is running the business with his deceased partner's 24 year old son. In another situation the wife of a business owner became the owner of a professional business when her husband died, but she did not possess the required license to operate the business. Both of these scenarios show the importance of business owners having a buy-sell agreement whenever they are in a business relationship.
A buy-sell agreement is a binding contract between the owners of a business that stipulates when a business owner can sell their interest, or what happens to the business owner's interest in the business in the event of death or the inability to remain a business owner. Whether it's a family business or a business arrangement with non-family owners, numerous issues can arise in the life of the business where a buy-sell agreement protects the interests of all the business owners.
There are many other areas that can change in a business that can be difficult to resolve without a buy-sell agreement, including when:
- One owner wants to retire, or is disabled and can't perform their duties as an owner;
- An owner dies, and the owner's spouse or children don't want to remain in the business;
- An owner divorces, and the ex-spouse receives an ownership interest in the business;
- An owner has financial problems, and their business interest may be attached as a lien by creditors or the Internal Revenue Service.
As you can see, while a buy-sell agreement certainly ensures a fair and equitable solution for the business owner who remains with the business, it also ensures each business owner, and their beneficiaries, are treated fairly in the event they want to leave the business, are unable to perform their duties or if they pass away.
Using the television commercial as an example, having a buy-sell agreement could have stipulated that, upon the death of an owner, the other owner could have bought out the deceased person's business interest, or brought in a suitable owner, rather than having to run the business with the deceased person's 24-year old son, who has no experience running a business.
Without a buy sell agreement the surviving spouse mentioned above, is at a decided disadvantage: she does not know the true value of the business and is required to liquidate the interest since she does not have the necessary license (The situation would be the same if the surviving spouse is required to sell the interest for financial reasons). To protect her interest the spouse will have to retain an attorney which will delay a disposition of her interest in the business, as well as increase the costs. The longer it takes to consummate a sale of the interest; the lower sales price.
If there had been a buy sell agreement in place the surviving spouse would know with certainty what she would receive for the interest and there would be no need for lengthy, complicated and costly negotiations to determine the value of the deceased owner's interest.
The surviving business owner also benefits by knowing in advance what the purchase price will be and the terms of the buy out. Furthermore, the surviving business owner knows with certainty who will be the owner of the business and who will be making future business decisions.
While a buy-sell agreement helps to establish the criteria for transitioning business ownership in these aforementioned instances, it also can establish a formula to be used in determining what the business is worth, thereby eliminating any disagreements between the owners.
For example, while most businesses start out with the best intentions, over time, the business owners may realize that they don't get along or may have a difference of opinion on the future direction for the business. In this instance, having a buy-sell agreement with a "deadlock provision" can clearly outline the process for one business owner to buy out the other, or to sell a business owner's interest to a new owner.
A deadlock provision is included in a buy sell agreement when the business is owned equally by two owners. If the owners fail to agree on important matters or fail to get along, there is a deadlock, which means neither owner can require the other to buy or sell their interest. To avoid a very costly and ultimately financially fatal dispute the deadlock provision provides a mechanism to resolve this situation without destroying the value of the business or the company.
A properly drafted buy sell agreement will include either a specific price for an owner's interest or a formula to determine the price. The purchase price will depend on the event that triggers the sale of the interest (for example death or disability).
In many cases, owners agree to purchase life insurance policies (assuming they are insurable and the cost is reasonable) to guarantee the deceased owner's heirs a lump-sum payment for the business interest in the event of death. In other cases the there isn't sufficient of cash necessary to buy out the business in a lump-sum. Therefore, the buy-sell agreement would stipulate the payment terms for the buyout (i.e., a set amount per month for 5 years, 10 years, etc.) The agreement also has a clause that will provide some security that the owner who is selling his interest will actually receive all the payments, or that their heirs will receive the payments in the event of death. Tax considerations are very important and will have a substantial effect on the amount that an owner can afford to pay for other owner's interest. If properly drafted a portion of the total consideration paid can be deductible which lowers the effective cost to the surviving owner.
In today's competitive business environment, many small businesses develop strategic plans to enable them to grow and prosper. However, a buy-sell agreement ensures that the relationship between business owners is also strategically planned.
With all the changes that can occur in a business relationship, having a buy-sell agreement can provide the owners with peace of mind and allow them to focus on the more important issues of growing their business. Without a buy-sell agreement, the only people who will enjoy the business dispute will be the lawyers who represent both parties.
If you are considering entering into a business arrangement with the other owners of a business, or are currently in a business arrangement and don't have a buy-sell agreement, please contact Ken Bloom (firstname.lastname@example.org) or Jonathan Goldberg (email@example.com) via email or at 248-932-5200 for more information on how a buy-sell agreement can benefit your business.
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