One of the most important questions owners of a new business must answer at its formation is what is the intended exit strategy under differing scenarios. A buy-sell agreement provides an orderly process for determining who can, or will, buy the shares and how the price will be determined if an owner wants to retire, sell his shares to a third party, goes bankrupt, gets divorced, dies or becomes disabled. It is often accompanied by insurance or other funding sources to enable the buy-out.
Without a buy-sell agreement, the departing owner, his estate, and the remaining business owners, do not know how the future value of the ownership interests will be determined. In light of today's many controversies about business valuations, this lack of certainty can create divisions among the owners and their families, lead to litigation, and result in unnecessary costs to all parties involved. Equally important, the failure to intelligently plan for an eventual departure can result in the inability of the owner to be able to extract a large portion of his/her wealth from the business when he/she, or his/her family most needs it and, in some cases can result in competitors, and/or creditors (including angry spouses), obtaining an ownership interest in the business.
Buy-sell agreements are entered between a business and/or its co-owners and typically addresses:
- Who has the right to buy the co-owners' shares, e.g., the company only (called a redemption agreement), co-owners only (called a cross purchase agreement), or a combination of both type of agreements.
- Whether the purchase by the company or co-owners of the ownership interest is mandatory or optional.
- How the purchase price will be determined, e.g., a fixed price, an appraised price, book value, capitalized earnings, fair market value, etc.
- How the purchase price will be paid, e.g., in a lump sum or over time together with interest.
- What the triggering events for the buy-out are, e.g., death, disability, divorce, retirement, bankruptcy, irreconcilable disputes, breach by the co-owner of the operating, partnership or shareholders agreement, desire by the co-owner to sell to a third party, etc.
- Whether insurance will fund the buy-out in the event the co-owner's death and what funding sources will be used for other triggering events.
Buy-sell agreements are not "off the shelf" products. Instead, they should be drafted to respond to the particularities of the business and the specific needs and objectives of the owners. The choice of options also has tax and estate planning implications that the business owners should seek legal advice in relation to. In addition, in order to ensure the availability of funds to effect a buy-out, investment, accounting and insurance advisers should be involved, together with legal counsel, to fashion a practical and cost-effective strategy. Finally, the buy-out formula should be revisited periodically in light of changing attitudes and conditions.
A buy-sell agreement is a very important mechanism for ensuring continuity of the operation of closely held businesses and for enabling co-owners (and their estates) to sell their shares when certain events arise. Attorneys at Mathieu, Ranum & Allaire are experienced in drafting buy-sell agreements and advising clients about the issues and options with respect to exit strategies and the tax, estate planning, and funding implications. If you are considering your options for a business exit strategy, please call us.