When two or more entrepreneurs decide to form a business, their heads are usually filled with optimistic fantasies about future profits. Rarely do the founders of a company presume that the business will fail or that an intractable dispute will threaten the existence of the business. But businesses, like marriages, often get involved with unanticipated disagreements. One of the best methods of protecting against such incidents is the preparation of a properly drafted buy-sell agreement.
The basics
A buy-sell agreement is a contract between the owners of a business that gives one or more owners the right to purchase the interest of another owner or owners upon specified events occurring. The agreement also specifies the price (or the method of calculating the price) to be paid for the interest of the departing shareholder and the mechanics of payment. Most successful buy-sell agreements contain similar terms.
The triggering event
A proper buy-sell agreement begins by describing the so-called “trigger events” that give rise to the right to purchase or sell an owner’s interest. The most common trigger event is the death or total disability of one shareholder. A second common trigger event is the occurrence of a dispute between two or more shareholders that materially impairs the operation of the business.
Other potential trigger events are a downturn in the company’s revenues or profits or the bankruptcy of one or more owners. A divorce can also be included in the list of trigger events if the divorce will transfer the ownership of the divorcing shareholder’s interest in the business. Other events can be added to the list of trigger events, provided that the buy-sell agreement gives a detailed description of such events.
Paying the price
The agreement must specify the price to be paid to the departing shareholder and the method determining that price. The mandatory buyout may not occur for several years, and the price provision must take this fact into account. The price should not be specified n the agreement; instead, the agreement should provide a method for determining the price at the time that the mandatory sale provision is triggered. Some alternatives include arbitration, mediation, appraisal by a professional business appraiser, or valuation by the firm’s outside accountant.
The agreement should also specify the mechanic of delivering payment and the shares to the proper parties.
Legal advice
Buy-sell agreements can be very complex legal documents, especially if the mutual sale and purchase obligations involve more than two parties. The advice of a knowledgeable business attorney can help prevent many errors in crafting a useful buy-sell agreement.