The development of a new business venture typically is an exciting time for the owners involved in launching a new enterprise. By definition, the owners of a venture about to launch are optimistic about a business' future. Indeed, if the principals were not optimistic, they would not be preparing to start a new business in the first place.
The understandable optimism associated with a new venture must be tempered by reality. One such reality is the possibility that the day may come at which an owner of a business wants to sever ties with an enterprise. Due to the nature of closely held businesses, this can prove to be a messy and even a catastrophic proposition in the absence of what is known as a buy-sell agreement. There are some key benefits to the owners of a business entering into a comprehensive buy-sell agreement in the leadup to the launch of a new venture.
Definition of a Buy-Sell Agreement
Also known as a buyout agreement, a buy-sell agreement governs the manner of separation in a situation a co-owner of a business desires to, must, or has departed from a business. There are three primary situations in which the co-owner of a business separates from an enterprise:
- voluntary departure
- forced departure
Basic Provisions of a Standard Buy-Sell Agreement
A standard buy-sell agreement typically has three basic provisions:
- a declaration as to who can purchase or otherwise take ownership of the departing owner's share of a business
- delineation of events that trigger an ownership buyout
- the price paid for an owner's interest
Preserve a Surviving Owner's Right to do Business with Desired Co-owner
A key benefit of an appropriately crafted buy-sell agreement is that this type of contract protects a business owner's right to be in business with a desired co-owner or owners. With a buy-sell agreement, a remaining business owner has control over whom he or she shares ownership of an enterprise.
Establishment of Fair Price for Interest in a Business
Another of the important benefits of a buy-sell agreement is that it establishes what the parties agree is a fair price for a co-owner's interest in a business. This can be established in a number of different ways, including an agreed formula for computing the value of an ownership interest in a business.
The stark reality is that the time a co-owner separates from a business can be fraught with high-running emotions. Determining what truly is a fair price for an ownership interest can prove to be highly challenging in that type of environment when no buy-sell agreement exists.
Ending a Departing Owner's Decision-Making Authority
With significant frequency, a co-owner of a closely held business may reach a point in time at which he or she no longer desires to be involved in operation of an enterprise. Absent a properly drafted buy-sell agreement, a co-owner who reaches such a juncture will still retain management authority. Such a scenario can create truly undesirable situation.
Estate Planning Instrument
As noted previously, one of the reasons why a co-owner departs a closely held business is death. A comprehensive buy-sell agreement can prove to be an important estate planning device. By crafting and entering into a buy-sell agreement, the co-owners have the opportunity to obtain thoughtful legal advice from a capable attorney to ensure that that a deceased individual's ownership interest is properly addressed with estate, probate, and tax laws in mind.
Three Basic Types of Buy-Sell Agreements
In conclusion, there are three types of buy-sell agreements that most often are utilized by co-owners of closely held enterprises:
redemption agreement through which the business itself buys the departing co-owner's interest
cross purchase agreement where the remaining owners purchase the departing or departed co-owner's interest
hybrid agreement in which surviving owners have the first option to purchase a departing or departed co-owner's interest, the business itself being required to purchase the agreement if a remaining owner does not
Due to the complexities associated with ownership interests of closely held businesses, obtaining experienced legal assistance in drafting a buy-sell agreement is always advisable. Professional legal assistance ensures that the rights and interests of all owners of a closely held business fully are protected via a suitable, enforceable buy-sell agreement.