Buy-Sell Agreements for Small Businesses - The "Business Pre-Nup"
It seems like business formation activity is starting to pick up as people are starting to not only thaw out from the winter but also thaw out from the "economic ice storm". Part of the process of any business formation involves consideration not only of creating the company but also terminating the relationship. Much like a premarital agreement predetermines how assets are split at divorce or at death, a "buy sell" agreement will determine how the business will continue or dissolve in the event of a death of an owner, disability of an owner, bankruptcy of an owner, the divorce of an owner or a dispute by the owners. None of these issues are typically on the near horizon when the process is starting, so it is easy to forget about them. However, most small businesses will end at some point. Better to start the planning now before too much is invested and when relationships are strong.
In looking at the issues, here is a brief outline of some items to consider as the business owner formulates a plan.
- Triggering Events
- Death
- Disability (consider length of necessary disability)
- Divorce by one owner (ex-wife digging through company financials?)
- Bankruptcy by an owner (bankruptcy trustee involved in company?)
- Desire of one party to get out of the company
- Valuation Issues
- Annually have the owners determine the value of shares by unanimous agreement or by appraisal or by some formula using company financials.
- Professional appraisal at time of triggering event
- “Texas Shootout” – one party submits price that they would either be willing to buy OR sell. Other party has option to either buy OR sell for that price.
- Can use combination of valuation issues with different triggering events.
- Funding Issues - Upon a triggering event, how will the departing member be paid for his or her shares.
- Insurance (life insurance, disability insurance, business continuation insurance)
- Installment payments
- Cash reserves of Company
- Company redemption vs. Cross purchase
- Determining whether the company will redeem the company shares or whether the other owners will be making the purchase (who buys the owner out - company or other owners?).
- This decision affects the valuation of the company and a shareholder’s basis in the company.
This outline is simply a starting list to get the thought process moving. The final provisions can either be placed in the formation documents, or a separate "buy sell" agreement. The drafting of such a document can be very complex and you should consult an experience attorney to assist with the drafting of such a document. Implementing the "business pre-nup" now will hopefully help smooth out the process later.