A buy-sell agreement is always a good idea when two or more people co-own a business. Also known as a buyout agreement, it protects the other business owners when a co-owner exits the business. A buy-sell agreement not only ensures protection for the company, but for the remaining co-owners and the departing owner as well.
When drafting a buy-sell agreement, there are six important considerations that should be addressed:
- Triggers. Typically, the life events that can trigger a buy-sell agreement include retirement, death, disability, divorce, or breach of contract. Your buy-sell agreement should specify the buyout triggers as well as options for passing along ownership shares to a spouse or surviving relative.
- Clauses. There are several buyout clauses that are common to buy-sell agreements that provide owners with different options:
- Shotgun — sets a specific share price if one owner wants to leave and sell all his or her shares.
- Wait-and-see — commits all the owners to a sale but defers the specifics until a triggering event occurs.
- Drag-along — commits minority owners to join majority owners in any share sale.
- Tag-along — commits majority owners to allow minority owners to join any sale of shares on the same terms as the majority owners.
- Buyer choice. If a departing owner is essential to the business, whomever buys his or her shares must also be capable of filling that leadership role. This is especially important for family-owned businesses where those best equipped to run the business should receive voting shares and others may be given non-voting interests.
- Purchase price. Procedures for determining the purchase price of a departing member’s shares should be detailed in the agreement to avoid conflict.
- Buyout flexibility. Depending on the needs of your business, the buy-sell agreement can be prepared to involve many forms of payment to the selling shareholder or estate. For example, you can choose payment via one lump sum or payments made over time. In addition, a life insurance policy can be procured to ensure the payments do not adversely impact company liquidity.
- Tax considerations. If the valuation is based on a standard that would conflict with the IRS’ application of highest-and-best-use valuation, you could be sitting on a tax bomb. Consult with a financial advisor to determine what will work best for your corporate structure.
When contract disputes arise, you need experienced legal representation and advice. Williams Commercial Law Group, L.L.P., is a law firm focusing on contract law, and business divorce. Contact us at (602) 256-9400 and schedule a time to meet with us today.