Four Elements of a Sound Buy-Sell Agreement
From developing a fool-proof business plan to selecting the perfect partners, you spent a lot of time and energy in tuning your business ownership dreams into reality, but did you take measures to safeguard your company and your interests in it? Life happens, and unfortunately, much of what goes wrong in our lives is out of our control. Divorce, death, and fallouts are a very real possibility, and each can spell financial disaster if not planned for. Fortunately, though one cannot anticipate many life-changing events, they can prepare for them, with a buy-sell agreement. Buy-sell agreements detail what is to become of an owner’s interests in a company should they be forced to leave the company for whatever reason.
It is not enough to have a buy-sell agreement in place. Buy-sell agreements should leave as little room for negotiation or interpretation as possible. At Cloud Willis & Ellis, our business litigation lawyers have drafted numerous buy-sell agreements over the years, each one designed to account for all possible scenarios and risks. In order to do that effectively, we make sure that each agreement includes clauses regarding the following:
- Triggering Events
- Valuing an Owner’s Interests
- Mandatory vs. Optional Purchase
Detail Triggering Events
First and foremost, a buy-sell agreement should explain what might be cause to enact a buy-sell agreement. Partners at most firms agree that events that may trigger an option or requirement to repurchase an owner’s interest include death, divorce, bankruptcy, disability, an adverse lawsuit judgement, retirement, termination of employment, and/or the attempted sale of one’s interest to a third party. Without such a clause, partners may have difficulty enforcing a buy-sell agreement when the partner in question is unwilling to sell his or her share in the company.
Valuing an Owner’s Interests
Perhaps one of the most debated issues among business partners is how the value of each owner’s interest should be determined. In an ideal world, everyone would have equal share, but the business world is not ideal—it is cutthroat. In order to guarantee that everyone’s interest is calculated fairly and in the same manner, there should be a clause in the buy-sell agreement that details the valuation method to be used. This clause should also answer the following questions:
- Who will calculate the value upon the occurrence of a triggering event?
- Will the person’s whose share is at stake have an option to appeal the board’s decision?
- Will there be a right to a second opinion?
Arriving at a decision regarding valuation methods should not be done lightly, and should only be done after a collaborative discussion between board members, owners, attorneys, accountants, and a financial advisor.
Mandatory Vs. Optional Purchase
A sound buy-sell agreement outlines what triggering events call for a mandatory purchase and sale, and which create an option to purchase or right of first refusal. For instance, the death of an owner might trigger a mandatory purchase and sale, while an attempted sale to a third party might allow for a right of first refusal from the other partners.
How Payments Will be Made
This is not as straightforward as one might think, and most people assume that an agreed upon purchase price will be paid in cash—that is, until they are confronted with a triggering event themselves. In the event of a death, most firms agree that the purchase price should be paid via life insurance, which results in an all-cash payout within six to twelve months after the death. However, other triggering events may require a deposit and a payment plan, which will be fulfilled over an extended period of time. These events may be a sudden disability, retirement, or termination of employment. To prevent confusion when the time comes, a buy-sell agreement should contain a clause that details exactly how the purchase price will be paid upon each triggering event.
Retain the Help of a Birmingham Business Litigation Lawyer
A buy-sell agreement is only as effective as you make it. If you want to ensure that your agreement is foolproof, and that when it comes time to use it there is no room for negotiation or interpretation, hire a business litigation lawyer for help drafting it. Call Cloud Willis & Ellis to schedule a consultation today, or reach out to their firm online.