My last newsletter discussed the need for business partners to have an agreement that clearly defines and allocates the responsibilities each partner will have in the day-to-day operation of the business. This article discusses the means by which those owners can prepare for the issues they will face when an owner dies, becomes disabled, becomes divorced, or just wants out. Addressing those types of issues in an agreement when the business is in the early stages of its life will usually eliminate a lot of emotional uncertainty, damage to the business, and litigation expense when life changes and the unexpected happens.
Commonly called a Buy-Sell Agreement (Buy-Sell), the agreement will typically specify what the owners must do in the event of the following:
Death
Divorce
Disability
Desire to sell equity
Disagreements fundamental to the continuation of the business
When two or more people form a business, and work in the business every day, they usually do not intend to one day have their partner’s spouse or child, or a complete stranger, step into their shoes. Without a Buy-Sell, if a partner dies, that partner’s spouse or other heirs then acquire the deceased’s share of the business even though they may not have any experience in the industry and even though the remaining partners do not want to work with them. The same is true in the event of a divorce. Since ownership in a business is presumptively a community asset, the divorce may award each of the divorcing spouses one-half of their combined equity position with the effect that the formerly non-owner spouse is now an owner with voting, distribution and other rights with or without working in the business. Disability presents many of the same issues. In those cases, it is often desirable for the other partners to buy out the interest that falls into the hands of the spouse or children. A well written Buy-Sell can protect the original owners’ interests in those situations and create a mechanism that allows them to continue the business in much the same way they originally envisioned.
If one owner decides to cash in and sell his or her interest to a third party, a proper Buy-Sell will trigger the other owners’ right to exercise a right of first refusal to purchase the equity interest. Similarly, if the owners become so deadlocked in matters essential to the continuation of the business, a Buy-Sell can provide a mechanism by which one owner buys out the other for a price that is fair and equitable regardless of the way the money flows. In both cases, it allows for the owners to retain their value and move forward without destroying the business.
A Buy-Sell should be entered long before it is expected to be needed. The provisions of the agreement can usually be more effectively negotiated before the need arises and while the owners are level headed. Moreover, since the owners do not know who will be potentially selling or buying, they will be able to negotiated in a manner that is ultimately fair to all. It also eliminates the possibility of one owner waiting things out if the other becomes ill or disabled with the thought that more leverage will be available if dealing with the spouse or children. Finally, funding tools such as life and disability tools can be explored and purchased, and are only available before the need for them arises. Proper planning in advance will help provide a smooth resolution if a triggering event occurs, and provide liquidity to enable a transition when needed.