Wednesday, August 17, 2005

Buy-Sell Agreements - Questions to Ask Yourself

Category: Business Law and Planning

A Buy-Sell Agreement should be a central cornerstone of your business. However, most business owners haven't really considered (1) if they need a buy-sell agreement (if you have partners, you absolutely do), (2) what it should say (some questions to consider are below), or (3) if they already have a Buy-Sell agreement in place, what that existing agreement says, and if it continues to meet your needs (which can be the most dangerous situation as you are contractually bound to something that no longer makes sense).

A Buy-Sell Agreement is designed to facilitate a more orderly transition in the event of situations such as these where one or more of the owners:
  • is fired or quits
  • wants out (either to the remaining owners or a third party)
  • dies or becomes disabled (do you really want to be partners with your partner's spouse????>
  • wants to buy-out another owner(for example, as a management transition, or to make her shares a greater percentage of the whole)

Some questions to consider in crafting your agreement (note that I always encourage my clients to hammer out a term sheet from a template I give them before we start drafting - a lawyer acts to advise and raise issues; as the business owners, you need to decide what your risk tolerance is and what works best for you):

  • Can an owner sell her interest during her lifetime? If so, to third parties or just to other owners. If to third parties, do the remaining owners have a right to purchase the interest first (a "Right of First Refusal")
  • Can an owner transfer his interest to a family member during his lifetime? If so, under what circumstances and to which family members. Do the family members have voting authority. Are there "drag-along" rights if the owner leaves - ie: if the owners sells out, must his family members sell as well.
  • What happens if an owner is fired or quits? Does it matter if it is for cause or not. Should there be some sort of penalty discount to the value of the owner's interest in this situation.
  • Who is going to purchase an owner's shares if he dies or becomes disabled and can no longer contribute to the business - the company or the other owners? Or can the family remain an owner.
  • Will there be a mandatory buy-out of one of the owners at some point? What is the triggering event for the buy-out?
  • How will the purchase price of the ownership interest be determined - by a formula relating to earnings, by one or more outside appraisers, by the owners determining a fixed value each year, by insuranance proceeds? Consider if the purchase price will have a discount percentage or inflation percentage in different situations (such as a discount if leave in first 5 years, or increase in the value in the event of meeting a triggering buy-out event?
  • How will the payment of the purchase price be structured? Consider having a certain percent down, and monthly or quarterly payments for a period of time thereafter. Will the payments have a floor or ceiling cap depending on how well the business is doing. Will the remaining owners be subject to restrictions during the payout period (ie: they cannot increase salary, take loans from the company, or get financing) without approval of the owners being bought out.

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