Buy-Sell Agreements are legal documents that govern how ownership will change hands in privately owned companies if and when something significant happens to one of the owners.
These agreements are intended to ensure the remaining owner(s) control the outcome during critical transitions, while making sure the transitioning owner (or their estate) are treated fairly and equitably.
Although owners may have the same interests while both are in the company and all is going well, these same owners may have wildly divergent desires and needs after a triggering event occurs.
It is not too hard to imagine a scenario where one wants operational stability while the other needs liquidity. For instance, if a partner dies, the remaining owner wants business as usual, while the deceased's estate wants to cash-out.
The interesting thing about Buy-Sell Agreements is that you do not know which side of the transaction you will be on when the agreement is drafted. Because of this, it is in both party's interest to make them as fair and equitable as possible.
There are several objectives to Buy-Sell Agreements. Here are a few:
- Keep company ownership limited to an existing group or family
- Ensure the on-going operation of the business
- Alleviate litigation in the event of a triggering event
Buy-sell agreements should specify:
Defines an event that is covered under the agreement. They include:
- Death - can't avoid this one!
- Divorce - hope for the best, plan for the worst
- Disability - plan for the unexpected
- Disagreement - the poster child for divergent interests
- Retirement - everyone's aspiration
The date for valuing the business is often tied to the triggering event.
For instance, if an owner is disabled, the valuation date might be defined as the date that disability insurance is activated, or it might be defined as the date which the disabling event occurred. For divorce, it is typically the date of separation. For death, well - that is pretty obvious. The date needs to be clear and defined.
The agreement should state how the valuation of the business will be determined when ownership interests are transferred. This could be a fixed price, formula, or methodology.
Best practice is to identify a single valuator that all owners agree to work with. The valuator values the business every 1 -2 years and the owners sign off on the valuation.
Then, if and when a triggering event occurs, the transaction is based on the most recent valuation. It is straight-forward and eliminates dissension as presumably both owners have already agreed to the value.
If a new valuation is required, then the same valuator and methodology is used.
Some (not all) companies have Life or Key Man Insurance policies to help fund the transaction.