A significant concern to owners of closely held businesses is what happens to the business if one of the owners can no longer participate in its operations. This situation commonly results when one owner of the Company dies. However, the same situation can result if an owner becomes disabled, retires, or loses his/her interest in the business through a bankruptcy or divorce. Forwarding looking business owners can plan in advance for such contingencies by preparing a buy-sell agreement which provides for the buyout of a owner’s interest in the business upon the occurrence of certain events. Such a plan will allow the business to move forward during a tumultuous time while making sure the selling owner or his/her family is fairly compensated for their share of the business.
If you are an owner of a closely held business a buy-sell agreement is essential for the smooth transitions of ownership in 7 key situations.
- Death – If an owner dies, the business can suffer significant financial setbacks. This can be even worse if the surviving owners have to take on a new owner – the deceased spouse or other beneficiary. A fully funded life insurance coverage can ease this situation together with appropriate provisions in the buy-sell agreement.
- Disability – If an owner is permanently disabled or disabled for a significant period of time the buy-sell agreement should discuss rights to salary, profits, decision making, etc. Addressing these issues up front in a non-emotional context can save a business significant time and expenses. Again insurance can offset the financial concerns.
- Departure – If an owner leaves by retirement or resignation, the issue of who can buy the departing owner’s interest and the associated price should clearly be spelled out in a buy-sell agreement.
- Divorce – If an owner finds him or her self in the midst of a divorce it is likely that the business interests will be an asset that must be addressed in the divorce. Just like with a death, other partners probably do not want the spouse to become an owner in the company. The buy-sell agreement should require that the interests be sold back to the company or the remaining owners at a predetermined price.
- Deadlock – If equal owners can’t reach an agreement, the business may be deadlocked and unable to conduct ongoing business operations. This should be avoided at all costs by allowing for third party decision making, an automatic liquidation provision, or a call option in a buy-sell agreement.
- Divesting – If there are unequal ownership interests it is possible that a minority owner may be forced out of the company in which case his or her interests should be bought back by the company or purchased by the remaining owners.
- Defaults – In most closely held corporations, the individuals must personally guarantee loans or even make certain payments on notes. The buy-sell agreement should address what occurs in the event an owner fails to guarantee, is not “eligible” to guarantee or defaults on a note.
Finally, one of the most important items in a buy-sell agreement is how the selling owner’s share of the business will be valued and how the purchase price will be funded. Buy-sell agreements can provide for valuation methods such as appraisals or predetermined formulas and can be funded by cash, insurance proceeds, promissory notes, or a combination of funding mechanisms.
If you would like more information regarding buy-sell agreements or if you would like us to review your buy-sell agreement, please contact our Business Law Group partner, David A. Closson at [email protected].