When two or more people decide to start their own business, they rarely pay much attention to the end of the business or to the choice of one or more owners to leave the business. Like a marital divorce, a small business divorce can be contentious and destructive of corporate value. The solution in both cases is a buy-sell agreement (the marital version is more often called a pre-nuptial agreement). A business buy-sell provides a predictable and unambiguous method of allowing one shareholder to sell his interest to the remaining shareholders for terms that are spelled out in the agreement. This post will provide a description of the most essential terms of a buy-sell agreement.
A buy-sell agreement can be signed at any time, but the best practice is to sign the agreement when the entity is formed or whenever a new investor is admitted to the entity. The agreement must describe the various events which allow one or more shareholders (or partners) to trigger the mandatory sale of shares. The agreement should provide that the trigger or notice be made in writing.
The agreement should describe the mechanics of the sale. Will it be a cash buy-out or will the departing member allow the remaining members to pay the price for the shares over time? The agreement may need an escrow agent to hold the interests of the departing member while the purchase price for his interest is paid off.
The buy-sell agreement will also establish a price for the departing member’s interest. Setting a specific price at the outset of the venture may not be wise if the members expect the value of the enterprise to increase over time. In such cases, the agreement should provide a method for determining a purchase price.
Many buy-sell agreements purchase life insurance policies on each shareholder. These policies can then be used to pay the purchase price for a deceased shareholder’s interest.
Many forms for buy-sell agreements can be found on the internet, but these forms may not fit a given situation. A better practice is to consult an experienced corporate attorney, perhaps the one who drafted the documents that formed the entity. A knowledgeable attorney will understand the circumstances under which the shareholders intend the agreement to take effect. A capable lawyer will know which terms are essential and which are optional and can provide useful advice to the ownership group.