I am amazed at the number of privately held business partnerships that do not have a formal buy-sell agreement in place. This one is absolutely essential. When forming your business, you chose your partner; make sure you have some rights when it comes to who your partner will be as time goes on too.
Part 4 in our series titled, “Your partnership will fail!“
Buy-Sell Agreement Fundamentals
By this point in our series, you have realized that – sooner or later, whether through an imbroglio fallout or buyout – your partnership will come to an end. Preparing for this inescapable event from the beginning allows you to continue to focus on the next steps in your life when that time comes. So far, we have offered advice on the importance of a Sweat Equity Arrangement and a Partner Salary Agreement. These deal with the past creation and current operations of your partnership. Today, we focus on the future termination of that business relationship.
We are all familiar with Stephen Covey’s The 7 Habits of Highly Effective People. Habit 2 is “begin with the end in mind.” Covey’s focus is on vision of what you want to achieve with your endeavor and taking daily steps to get there. I would like to offer a different perspective on this same concept. It is wise to begin your partnership knowing it will someday come to an end and protect your interest today when tomorrow comes.
Let me paint a few scenarios:
- Your partner is also your best friend.
Your business is growing and things are going well, at least at work. At home, however, your partner’s spouse has just filed for divorce. 2 months from now, your partnership of 2 becomes a partnership of 3. I hope you have a great relationship with your partner’s ex.
- Your partner is headed to Austin, TX to meet with a key customer.
She decides to take her husband along for the trip and make it a long weekend. Along the way, a drunk driver crosses yellow and the couple doesn’t survive the impact. No worries, her 18 year old son is the sole heir of your partner’s stock.
- Your partner receives a recruiting call from a well-established company needing his expertise.
The offer is too enticing to pass up. They have a friend who is interested in buying your partner’s stock. You’ve never even met the individual with whom you are about be in business with.
An essential element of beginning with the future in mind when it comes to business partnerships is a buy-sell agreement.
A well-formed buy-sell agreement doesn’t have to be complex, yet it will offer a means of protecting your business interests for any of the scenarios described above. There are many variables and options that come into play when developing a buy-sell agreement:
- Trigger Events
- Restriction of Ownership Transfer
- Valuation of Interest
- Funding Mechanisms
Some of the most common provisions that cover these variables are:
- “Identifies the sole proprietor and the purchasing employee(s) as parties to the agreement.
- A statement which identifies the business by name and location and the agreement of the parties to sell and purchase the business upon the death of the owner.
- Identification of the business assets and liabilities in order to keep them separate from the proprietor’s personal assets and liabilities.
- A statement which provides that the key employee has first call to purchase the business if the owner decides to sell it during his/her lifetime.
- A specific provision which binds the employee to purchasing the business upon the death of the owner and whereby the owner binds the estate to the sale of the business.
- A definite purchase price or a formula for determining the purchase price upon the death of the owner.
- To purchase and maintain life insurance on the owner by the purchaser.
- For the disposition of the life insurance policy should the agreement be terminated during the lifetime of the parties.
- For the payment part of the purchase price if at the time of death, the life insurance proceeds do not provide for the full price of the business.
- Establishes who will be responsible for the debts of the business (purchaser or estate) upon the death of the owner.
- General provisions which allow for changes or amendments to the agreement.
- Binds the heirs to compliance with the agreement.”
(from Business Basics, Ch. 4)
Protect your company; protect yourself – develop and execute a buy-sell agreement.
DISCLAIMER: This article may discuss issues for which legal advice should be considered prior to a decision or agreement with a third party. It should be noted that the author is not an attorney, and FundingSage is not a law firm. FundingSage’s employees and affiliates do not provide legal advice. We recommend you seek the services of an attorney if legal advice is required.