Buy-Sell Agreements

A Buy-Sell Agreement is an Owner’s Exit Strategy. 

A Buy-Sell Agreement is designed to create a mechanism for the orderly acquisition of the membership interest of a member of an LLC or the shares of a shareholder of corporation if the member or shareholder leaves the business.  The Buy-Sell Agreement creates a binding legal obligation for the departing owner to sell his interest or shares and the remaining owners or the company to buy the interest or shares.  Typically it describes how the purchase price will be calculated and the terms and conditions of the purchase.

Relationships end for many reasons and sometimes unexpectedly.

Small businesses in particular tend to be closely held and the owners generally desire to keep things that way.  These owners often place restrictions on the ability of the members or shareholders to transfer their interests or shares.

It is risky to believe that your co-owners will still be with you several years down the road.  It is likely that there will come a time when one of your co-owners will want to sell his or her interests or shares in the company to someone else.  An unexpected change in ownership can be very disruptive to a business.  It is best to have considered the issues relating to both the transferability of ownership and the termination of the relationship before the parties end their business relationship.

A Buy-Sell Agreement is like an insurance policy.

It is a cost of doing business that you hope you never need, but when you need it, you are really glad you purchased it.  A good Buy-Sell Agreement is an important part of your business plan.  No prudent business person would invest in a new business without first creating an exit plan.  Without a Buy-Sell Agreement, at the time an owner wants to leave a business it is unlikely that everyone will agree on how to end their business relationship and how much money will change hands!

Important considerations.

What events trigger the Buy-Sell Agreement?  Common events that should be considered include retirement, moving, death, divorce, termination of employment with the company, disability, and filing for bankruptcy.

Who can buy the interest or shares?  Many times, a buy-sell agreement provides the remaining owners and the company a right of first refusal before a departing owner can sell his or her interests or shares to a third party.

How will the company be valued?   An important task of the Buy-Sell Agreement is to state how the purchase price will be calculated.  The most common methods for valuing a business include:

• Stated Value Method:  The owners agree on the value of the company and they state this value in the Buy-Sell Agreement.  It is important that the owners update the price regularly because the value of the company always changes.
• Formula Method.   The owners agree on a formula to compute the value of the company.
• Appraisal Method.   The selling owner and the company mutually select an appraiser to value the company.

How much can the company spend on the buy out process?  Are there restrictions on the amount the company can commit to each year in the buy out process so as to avoid liquidity issues?

How will the buyout be funded?  One way to fund the purchase of the interest of a deceased owner is for each owner or the company to purchase a life insurance policy on the lives of the other owners.

What are the terms and conditions of the purchase?  Once an owner becomes obligated to sell and the company or other owners become obligated to buy, the Buy-Sell Agreement sets the terms and conditions applicable to the sale, particularly how the purchase price will be paid (cash and/or promissory note) and specifies the time for payment.

Buy Sell Agreements can be tricky. For more information, please contact Kathy Tremmel at Tremmel Law, PLLC at (512) 539-0317 or kathy@tremmellaw.com.

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