Private company business partners have had to combat considerable challenges amid the ongoing coronavirus pandemic, and with uncertainty looming large over the future economic climate, those challenges are likely to persist.
While some companies have been able to find financial resiliency and relief in the form of stimulus aid, business interruption insurance claims, or comprehensive strategies, many have faced issues which exacerbate pre-existing rifts between partners and their visions for the future. Compounded by COVID-19, that will naturally lead some partners toward business divorce, a process that is much more effectively managed when there are clear exit strategies and buy-sell agreements in place.
Though cutting ties with a partner is manageable without such agreements, companies looking at the long road ahead should prioritize the negotiation and adoption of mutually beneficial contracts. A carefully constructed buy-sell agreement – especially one that takes the current pandemic into account – can help avoid prolonged and costly conflict that only adds to disruption, and threatens personal relationships.
How a Buy-Sell Agreement is Triggered:
When establishing a business buy-sell agreement, it’s important to determine when the agreement can be triggered. Mutually beneficial agreements provide both sides with the right to trigger a buyout or redemption. That may mean:
- For majority partner who may not want to remain in business with a minority owner, a redemption right to repurchase the minority owner’s interest.
- For the minority owner seeking options should it come time to leave, a put right that allows a buyout from the majority stakeholder, and the monetization of their interest in the company.
For companies creating buy-sells during COVID-19, it may be worthwhile to explore a delayed trigger. This means neither side will have the right to trigger a buyout for a certain period of time – usually of a duration that would allow the company to “weather the storm” before a buyout takes place.
When a Buy-Sell Agreement is Triggered:
In addition to how a buy-sell is triggered, parties negotiating these agreements should be mindful of when they are triggered.
- Minority investors should seek provisions for a look back period as part of the agreement, as it will ensure they receive additional payment to compensate for the value of any advantageous sale that takes place after their ownership interest was redeemed by the majority owner, and to which they would have been entitled to had they remained an owner when the sale took place.
- Both parties should explore provisions that require an appropriate notice period. This protects against surprises, and provides the other partner with time to prepare. Some agreements may require 6 months or longer before the right to trigger the buy-sell is permitted.
Valuation in Buy-Sell Agreements During COVID-19
Agreeing upon the method of valuation in a written agreement can prevent disputes between partners who push for valuation most favorable to their position. Valuation methods vary from business to business, and may use a defined formula (i.e. a multiple of revenues), or allow the party who triggers the buy-sell to retain a business valuation expert, and the other to retain their own to provide a competing valuation. In the event that valuations differ by more than, say, 10%, agreements can be structured so that a third expert must be retained and the average of the three valuations will be used.
Regardless of method, all partners should determine whether any minority discounts will apply, including those that account for unmarketable interest, and a minority owner’s lack of control over business decisions.
Majority owners may agree to have one of the minority discounts apply, or for none to apply if the minority owner agrees to a delayed trigger and relinquishes the right to trigger the buy-sell for a certain period of time. This may be an important consideration given many companies’ uncertain futures during the pandemic.
Other Considerations With Buy-Sell Agreements
- Structured Payments: Buy-sell agreements can call for a minority owner to be paid in a structured buyout over a pre-determined period of time. If companies are going through lean times during COVID-19, negotiating a longer period may be advantageous to majority owners. Agreements can also outline what’s to be paid up front, whether interest is paid, the interest rate, and the time majority owners have to pay interest, and if collateral will be provided in the event of default.
- Ownership Limitations: Buy-sell agreements can establish ownership limitations that ensure partners don’t end up with a partner they don’t want, such as in the event of death or a partner’s marital divorce. Other limitations may also require retired partners to sell their stake if they no longer participate in the business, or relinquish their voting rights.
- Conditions of Sale: Partners can establish rules which govern the conditions of the sale of an ownership stake in the business. Will approval be required from all partners or the majority? Where will funds come from? Agreements can be tailored to include precise terms and conditions for such matters.
No one wants to envision the dissolution of a partnership, but amid these difficult times, it’s in every partner’s best interest to prepare for such events in a manner that mitigates disruption and dispute if they do occur, and allows companies to continue their missions. While we await America’s “Re-Opening,” it may be a good time for partners to evaluate their existing business contracts, or take the time to negotiate and draft a clearly defined, comprehensive buy-sell agreement.
Hendershot Cowart P.C. is a Houston-based law firm with decades of experience assisting business owners throughout Texas and the U.S. with negotiating, drafting, and enforcing business contacts. Contact us to speak with an attorney.