Ins and Outs of Buy Sell Agreements
Provided by HG.org
Buy-sell agreements establish important rules regarding when co-owners are able to buy each other out, when an owner can sell an interest, when an owner can buy another owner’s interest and what price is ultimately required to be paid. Carefully preparing a buy sell agreement can protect business owners’ interests for years to come. The agreement guides the buyout process.
When Are Buy Sell Agreements Applicable
Buy sell agreements apply in different situations, depending on the language in the agreement and state law. They often apply in situations in which an owner divorces, becomes disabled, goes bankrupt, retires or dies.
To be most effective, the buy sell agreement should be put in place at the beginning of the formation of the business. At this time, the owners likely share the same goals for the company and are optimistic about its chances for success. The owners may be more level-headed than they might be in other situations, such as if they suffer a medical crisis or are going through bankruptcy or divorce. The owners may agree to the basic provisions of the buy sell agreement at the early stages of the business. Additionally, if the owners wait until a problem arises, the owners may have competing interests that affect their decisions. Buy sell agreements that are instituted at the beginning of the business also help to reduce the emotional impact of the decision.
How Divorce Affects Ownership Rights
In many states when an owner of a business goes through divorce, his or her interest in the business may be subject to division. The asset may be considered a marital asset or an asset that increased in value during the course of the marriage or with the other spouse’s contributions. In community property states, all earnings that are made during the marriage are considered community property and thus should be equally divided between the spouses. In non-community property states, the asset may still be subject to division because the court must order property to be divided in a fair manner.
In order to avoid the possibility of having to go into business with an owner’s ex-spouse, a buy sell agreement may mandate that the ex-spouse sell the ownership interest back to the other owners.
How Bankruptcy Affects a Business Interest
In bankruptcy, a bankruptcy trustee is appointed to determine how to liquidate assets and pay off a portion of debt. In some cases, the bankruptcy trustee could liquidate the owner’s interest and sell off assets in order to pay the debtor’s debts. A buy sell agreement can address the possibility of bankruptcy and may require the debtor to notify the other owners before the debtor files bankruptcy so that they have a chance to purchase the debtor’s portion of the business.
The buy sell agreement should contain information regarding how the value of the business interest will be determined. The parties will have competing interests with the selling owner to want to have the highest sales prices and the remaining owners wanting the lowest evaluation. Determining a fair and objective way to evaluate the business before there is ever a thought about a potential sale can keep things cordial between the owners.
The valuation may be based on the opinion of a professional appraiser. The parties could also base the valuation on a specific formula or a multiple of a figure such as net profits. Other approaches are to value the business based on market indicators or calculating the total value of assets in the business. The parties may even agree to have the business evaluated periodically and to use that figure if a purchase is necessary.
Buy sell agreements may incorporate other ground rules. They may indicate who can and cannot be a buyer. They may also indicate how such a sale is funded, whether it is a lump-sum purchase or consists of payments made over time. The agreement may specify that if the owners do not have enough money to buy out the seller’s interests that they will provide a down payment and then make installment payments for a certain amount of time. There may also be triggering events that can cause a sale to become necessary. The buy-sell agreement may also specify that the owners will minimize tax implications during the sales process.
Seek Legal Assistance
Individuals who believe that they would benefit from a buy sell agreement may wish to contact a business lawyer for assistance to protect their legal rights.
Read more on this legal issueBuying or Selling a Business: The Importance of Using a Lawyer and an Accountant
Disclaimer: While every effort has been made to ensure the accuracy of this publication, it is not intended to provide legal advice as individual situations will differ and should be discussed with an expert and/or lawyer.