11th Sep 2013
People who have an ownership interest in a closely-held business often worry about what will happen to the business should the current ownership group shift somehow. What if something happened to one of the owners? What if someone wants out of the business? Business owners can secure peace of mind and ensure continuity of business operations by drafting buy-sell agreements that govern economic transactions among business shareholders in the event of triggering circumstances. Business owners should understand the purpose of buy-sell agreements, the issues they address and some common mistakes people make in drafting them.
What Is the Purpose of a Buy-Sell Agreement?
A buy-sell agreement spells out how the business owners want sales of shares of the company to happen. The buy-sell agreement should reduce shareholder disputes and litigation because all parties agree to the provisions of the plan before signing. In order for buy-sell agreements to be most effective, business owners should take an active role in drafting them, with the assistance of trained legal counsel.
Buy-sell agreements also offer a measure of protection to the business itself. The agreement should eliminate the possibility that the company will be faced with liquidity issues as a result of a stock transaction for which it was not prepared.
Finally, shareholders can draft buy-sell agreements so the provisions protect them and their families by including insurance coverage for funding the purchase of shares.
What Issues Do Buy-Sell Agreements Address?
Experts note there are seven major “triggering events” that buy-sell agreements should cover:
- Death of a shareholder
- Divorce of a shareholder
- Disability of a shareholder
- Retirement of a shareholder
- Separation from employment
- Sale of shares
- Bankruptcy of a shareholder
Each event could have different terms based on the circumstances of the event. For example, a buy-sell agreement could stipulate that a shareholder who divorces must turn in shares to the company in exchange for a promissory note so that the ex-spouse does not obtain shares in a property settlement. In the event of a sudden separation from the company, shareholders may need to agree to long-term payouts for shares to protect the company’s liquidity.
What Are Common Mistakes in Buy-Sell Agreements?
One of the most typical mistakes in buy-sell agreements is adding a provision that an outside source will value the shares when a triggering event occurs. Leaving the value of the shares as an unknown factor prevents business owners from knowing whether the rest of the agreement is properly drafted, such as insurance requirements and payout provisions. It also prevents shareholders and their families from being able to plan accordingly.
Experts suggest using an outside valuation advisor to determine a formula for valuing the shares that each shareholder can use to calculate share value using annual financial statements.
Other common mistakes include failure to properly fund the buy-sell agreement, failure to account for minority and majority shareholder differences, failure to outline shareholders’ rights and responsibilities after a triggering event, and failure to include important triggering events.
Consult an Attorney
Drafting a sound buy-sell agreement is a vital step for closely-held business owners. While some may hesitate to seek legal assistance in creating such an agreement because of the perceived costs, the time and money that businesses save by drafting buy-sell agreements properly far outweigh the upfront expense. If you are a business owner and have questions about buy-sell agreements, speak with an experienced business lawyer today.