Going into business with others is kind of like getting married. You have to make sure you're compatible, it takes hard work to be successful, and you don't know exactly what the future holds. For this reason, just as some people choose to sign a prenuptial agreement when they get married, business owners often choose to sign a buy-sell agreement when going into business together.
Outside the business, each owner's life will have its ups and downs and twists and turns. Various life events have the potential to disrupt the business. A buy-sell agreement (or buyout agreement) is a document that plans ahead and dictates what will happen to an owner's share if something happens.
Some common “triggering events” anticipated and provided for in a buy-sell agreement include:
- Death of a partner, shareholder, or member
- Death of the spouse of a partner, shareholder, or member
- Withdrawal from the business
Without a buy-sell agreement, the above can be disastrous. For instance, the death of a partner could trigger automatic dissolution of the partnership, depending on applicable law. Or if one business owner gets divorced, that person's spouse might acquire a share of the business in the dissolution proceedings. A buy-sell agreement provides an orderly and favorable way to handle the departing owner's share and keep the business running smoothly, and protect control of the business from outsiders.
The options for how to set up your buy-sell agreement are fairly flexible. The three main types of buy-sell agreement are:
- Redemption agreement: In a redemption agreement, the business itself is the party that purchases the relevant share of the business.
- Cross-purchase agreement: Here, the remaining business owners serve as the purchasers in the case of a triggering event.
- Hybrid: A hybrid agreement is a more flexible type of agreement. Often it will allow for redemption or cross-purchase as an optional first method, and if it's declined, then the other option becomes available.
Which type you use will depend on the type of business you have and the goals you are trying to achieve with the agreement.
Funding the purchase price in the event of death
Typically, to fund a buyout in the case of death, life insurance policies will be taken out on each business owner. The proceeds of the life insurance policy are then used to buy the deceased's interest in the business from the estate. When the buyout is required, this also serves as a method to provide for the family of the deceased.
Buy-sell agreements can provide for other scenarios as well, such as when one business owner wants to sell his or her share to an outside party. The agreement might require the selling party to provide a right of first refusal to either the business itself or to the other owners. The idea is to make sure the business keeps running, and the remaining owners maintain control as they see fit, with no surprises. A well-drafted buy-sell agreement provides peace of mind knowing that your business is prepared for unexpected life events.
Helix Law Firm can draft the right buy-sell agreement for your business
We can discuss your options and help you come up with the right solution for your business needs. If you're interested in creating a buy-sell agreement for your business, please call us at (619) 567-4447 to schedule a free consultation.