Starting a business with co-owners is a little bit like getting married. At the front end of the venture, all the owners get along and everyone is happy-just like in a marriage. After a while, some bumps in the road occur, and as things start unraveling, the relationship deteriorates and one of the co-owners files a law suit to break up the business association—just like in a marriage. After a lengthy period and the expenditure of a lot of money on legal fees, everyone is pretty well worn out and tired of paying legal fees, resulting in a settlement that no one is happy with—just like in a marriage.
I’m happy to say that in the business world, while not being able to avoid the divorces that sometimes occur, there is a way to enable the parties to extract themselves from a bad business relationship without the expenditure of a lot of emotional energy and cash on legal fees. That is by putting in place a buy/sell agreement, shareholder agreement or whatever title the parties may use. This is best accomplished at the front end when it is still the “honeymoon“ phase. If not done then, it becomes progressively more difficult to get an agreement in place as time passes, and the little differences start becoming big differences until the point when it is simply too late to get the parties to agree on a buyout scenario.
A good buy/sell agreement has at least five components that need to be addressed. Those can be summarized as follows:
- Triggering events. Common events are death, disability, retirement, termination as an employee, forced buyout and involuntary conversion.
- Determining the value of the business. A few common methods and combinations of methods are industry formulas, annual valuation updates by owners and business appraisals.
- Determining the purchase price for the departing owner’s interest. The purchase price for the member’s interest could be a straight pro rata amount of the value based on his or her ownership percentage or could take into account various discounts, such as minority interest or lack of marketability. Whatever method is used should be clearly stated.
- Payment of the purchase price. Will the purchase price for the departing owner’s interest be all cash, all promissory note or part cash and part note? What will the interest rate be? What will be the length of the payout term if payment is deferred over a period of time?
- Securing the deferred balance of the purchase price. If the departing owner is not paid in cash, the first question is whether the deferred portion of the purchase price is secured to ensure the departing owner is paid. If so, what is the security? It could be a pledge of the ownership interest being acquired, other assets of the business, other assets of one or more remaining members or the personal guarantees of the remaining owners and their spouses.
I’ve heard many excuses over the years why people choose not to do one of these agreements to avoid all of the divorce pain later. “We’re too busy.” “We’re all good friends.” “We’ll never have a problem.” “A buy/sell agreement is too expensive.” “We need our capital for building the business, not for spending on more legal agreements.” “We want to see how the business goes and will get to this later.” And on it goes. Experience shows that a good buy/sell agreement is sound business planning and an integral part of business operations with multiple owners.
We’re here to help if you would like to have us review an existing agreement or assist you in implementing a new buy/sell agreement, keeping your business “marriage” on sound footing.
Disclaimer: This blog is for information purposes only. Legal advice is provided only through a formal, written attorney/client agreement.