So the time has come when you are ready to start up a business and will be partnering up with someone else to pool resources or are planning to bring on a junior partner. While creating your business plan, setting up new bank accounts, and negotiating on that lease or property purchase, if you are bringing in other partners, it’s important to also add to that “to do” list – a buy-sell agreement.
What is a buy-sell agreement? A buy-sell agreement is an agreement between business owners that determines when owners can sell their interests. It is somewhat analogous to a prenuptial agreement between business owners. As much as partners often have rosy expectations going into a joint venture, it’s just as important to consider what might happen if expectations don’t work out. Also referred to as a “buyout agreement”, a buy-sell agreement can avoid disputes that might otherwise put the business at financial risk or result in costly litigation. In general, the terms of buy-sell agreement should address the following:
- When owners can sell their interest (i.e. limiting the sale to other owners within the business, or placing restrictions on others wishing to buy into the business).
- What events will trigger a buyout (i.e. disability, retirement, death, or when an owner simply wishes to leave the company).
- What price will be paid for an owner’s interest.
There are many different scenarios for entering into a buy-sell agreement. For example: (i) you are equal partners working together, sharing in the risks, and making the same capital investment, (ii) one of you is going to be working at the business every day and putting in the “sweat equity” while the other is providing the capital, or (iii) you have a key manager and are willing to give that person a percentage of the business over time to retain and reward them for loyalty.
With a buy-sell agreement, although not every possibility can be foreseen, spending time on this up front will reduce the possibility of friction between owners when a triggering event happens and one of the owners is no longer capable of being part of the business or wishes to leave the company. One key advantage of a buy-sell agreements is that they are typically reciprocal. Neither owner can foresee who will be the first to leave by reason of disability, retirement, or death. Keeping the agreement reciprocal often makes negotiating these terms easier to come to consensus on and reach agreement. It should be noted though that not one size fits all – the price may be fixed, established by appraisal, or determined by some other formula or multiplier. The price can be paid in cash or provide for installment payments over time. Terms and the price can vary depending on the triggering event. Life insurance may also be required for key managers/owners to protect the assets and continuity of the business.
Almost any business with multiple owners can benefit from a buy-sell agreement. By addressing these buyout issues up front, you will save considerable time and money valuing the ownership interest and setting out the requirements for sale of those interests when the time comes and such triggering events occur.