Business Buy-Sell Agreements: Why You Need One!
If you have one or more business partners then you need to have a buy-sell agreement in place. Think of a buy-sell agreement like a prenuptial agreement for your business. The agreement sets into writing what will happen if one of the owners leaves, retires, becomes inactive, files for bankruptcy, must be bought out, wants to bring in another owner, or any other number of conditions that may affect the health of the business as conditions between owners’ changes. Let's have a look at some of the elements that make up a common buy-sell agreement in Texas.
Company Valuation Method
This one is especially important. Because there are a variety of ways to determine the value of a company, having a method that is agreed upon before it is needed prevents any fighting that may occur as owners push for the method most favorable to them to be used when it is needed. Because every business is unique, with unique mixtures of assets and income sources, having a valuation method that fits your business is important. It will ensure that everyone gets a fair deal when the time comes to buy or sell parts or all of the business.
There may be scenarios where you want to limit who can become an owner in a business. In the case of retirement, death, bankruptcy, or divorce of one of the owners, a spouse or estate may be entitled to part of the business. A buy-sell agreement can set forth rules which state that ownership shares obtained without the permission of other members must be sold back to the business. This will ensure that owners never end up with a business partner that they do not want. It also illustrates why the valuation method is important to have in the agreement.
The agreement may also put other limitations on ownership. For example, an owner may be required to sell his or her shares if they retire and are no longer actively participating in the business. Alternatively, the owner may be allowed to keep their shares, but be required to give up voting rights on business matters. It may specifically exclude certain individuals or entities from owning an interest in the business. The specifics of each agreement will depend on the individual owners and their relationships.
When the time comes to sell the business, owners will want to have in place an agreed upon set of rules. Perhaps a large company has offered to buy the business out. Do you require approval from all owners or only a majority of them? How is majority defined? A properly written buy-sell agreement will put in place a very defined set of terms for what happens when any or all of the business shares are up for sale.
The agreement will also have in place some plan to fund the sale of an interest in the business. If a buyout is necessary, where does the money come from? Is the business required to have a life insurance policy for each of the owners? Will some of the profits be set aside in a sinking fund to ensure that the remaining owners have cash on hand to buy out the departing owner? Does the payment have to be lump-sum, or can it be split over a number of payments? Having all of this figured out ahead of time makes the process much smoother when the need for a buyout arises.
Buy-Sell Agreements – Common Questions Answered
If you are thinking of having a buy-sell agreement drawn up for your business, you may have some questions. Do you need one? What circumstances should you plan for? We've included some of the most common questions and answers below:
- Which businesses need a buy-sell agreement? All businesses that have more than one owner should have a buy-sell agreement in place.
- What happens if the company cannot afford the buyout? This is something that needs to be thought of when the agreement is drafted. Allowing for a payment plan over a lump sum requirement, requiring a life or disability insurance policy on all members, and setting up a sinking fund are all ways to ensure that the business will be able to cover its expenses when a buyout is needed.
- How does divorce affect the business? In a community property state like Texas, spouses may receive a portion of the business in a divorce. A properly drafted agreement will determine whether the spouse will be allowed to maintain that interest, or whether they must sell it back to the business.
- How does bankruptcy of an owner affect the business? Like a divorce, a bankruptcy of one of the owners may put interest in the business at risk. The buy-sell agreement should include terms that indicate what happens in case a member files for bankruptcy.
- How should a business be valued? The agreement may set forth an agreed upon valuation method that matches well with the operations of the business. It may also set forth an agreed upon appraisal company and method to perform an appraisal when the need arises.
Hendershot Cowart, P.C. has over 150 years of combined experience in business law. Please contact us today to find out how our Houston business lawyers can help you set up a buy-sell agreement for your business.