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A buy-sell agreement is any agreement among the owners of a business and the business itself concerning the ownership of equity interests, management of the business, and the rights of the entity and an owner to purchase the ownership interests of the other owners. The buy-sell provisions can include all owners, or some, and may be contained within the governance document or in a separate document.
The issues a buy-sell agreement may cover generally include transfer restrictions; provide a market for an illiquid investment; provide a tax value for estate purposes; prohibit competition; and resolve a deadlock among owners. Regardless of the issue, it is important that parties to the buy-sell agreement periodically review and update the agreement to address changes in the business itself. For example, a life insurance policy purchased in year three on the owners to buy the company for $5 million may be insufficient in year seven where the company is now worth $15 million. Because the fortunes of the business and its owners change, the buy-sell agreement should also be amendable to clearly reflect the business’ situation.
Buy-Sell Agreement Provisions
A buy-sell agreement contemplates that certain events will trigger an obligation either of an owner to sell his interest or grant the other owners or the business an option to purchase the interest. Examples of triggering events include the death or disability of an owner, divorce of an owner, retirement, loss of license, or termination of employment.
One of the most important provisions of a buy-sell agreement is the methodology to determine the purchase price of the interest. Obviously the purchaser(s) will want the lowest value possible, while the seller(s) will want the maximum value. There are three ways to determine the purchase price: 1) agreement of the parties; 2) use of a formula; and 3) valuation by a third party. The method of valuation may change over time depending on the success of the business and whether additional related or complimentary businesses are created.
Additional Issues to Consider
Additional issues to consider when drafting the buy-sell agreement may include cancelling personal guarantees of business debt, whether a global buy-sell agreement is appropriate where the owners have multiple related businesses, and the form, timing and amount of payments. The clearer the terms of the buy-sell agreement, the fewer disputes and disagreements over interpretations of the agreement’s terms will arise.