First, what a Buy-Sell Agreement is NOT: A buy-sell agreement is not an agreement to buy or sell a company.
A Buy-sell agreement is a binding contract between co-owners (partners, members or shareholders for instance) that controls when certain events occur that provide for how owners can sell their interest, who will be permitted to buy an owner’s interest, rights of first refusal, and what price will be paid. In essence, a buy-sell agreement is (and are often referred to as) a “buyout” agreement.
Buy-sell agreements come into play when an owner wants out of the business, retires, dies, faces bankruptcy, becomes disabled, or commonly, gets divorced.
All Companies. Buy-sell agreements are important for any business entity, whether a startup, or a going concern, and whether an LLC, C-corp, S-corp, or partnership. Buy-sell agreements are best incorporated into an LLC Operating Agreement or a Corporation Shareholder Agreement. Simply, every co-owned business needs a buy-sell agreement at the moment the business is formed or as soon as possible after formation in order to protect the business owners when a co-owner wants to or is forced to leave the company. While it is easy and tempting to “kick the can” down the road, owners often leave companies at early stages – even within months of formation. Value is added to your business daily and a business without a plan for transition is a business at great financial risk. Knowing how to buyout the departing member at an early (or late) stage is critical to the business and remaining owners.
Every business with multiple owners needs a Buy-Sell Agreement.
An effective buy-sell agreement will protect the departing owner and, importantly, the remaining owners and company. For example, lets say you and Emily form a Colorado LLC to make virtual widgets that corner the iPhone 6 market. Everything is great and cash is flowing. Then, Emily decides to get divorced. You’ve never really liked her husband and now you really don’t like him – he is demanding 50% of Emily’s ownership and has big plans for the Company (something about using all cash reserves to buy all Zune intellectual property and product back-stock.) What you, Emily and the Company can do must be clearly spelled out in the Company’s buy-sell agreement. Whether Emily’s Ex is entitled to ownership of any of her interest may not be for you to decide, but through a proper buy-sell agreement, your Company can ensure that Emily’s ex-husband is not involved in the operations of the Company.
Valuation. Effective buy-sell agreements allow owners to agree on a method by which the company is valued in advance of the buyout. Business owners always want to control their own destiny – and a buy-sell agreement gives owners the opportunity to discuss and vote on how to calculate a reasonable price for the company. Whether you elect to use a valuation formula or instead hire a professional appraiser, agreeing on how to value the company early will go a long way in avoiding conflict when it matters.
Get It Right. Getting the buy-sell agreement right – out of the gate – is important. You really must consult with an experienced business attorney to help you choose the right type, negotiate, draft – and most important and often over looked until its too late – understand it. Buy-sell agreements can be simple and may be very cost effective when drafted as a part of an operating agreement or shareholder agreement. Whatever you spend on a buy-sell agreement, it will be a drop in the bucket compared to what you will save in lost profits, time and litigation costs down the road.
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