Issues can arise in businesses with a close-knit group of partners when one partner departs the business, whether due to disability, incapacitation, retirement, divorce, or death. Business partners can avoid potentially distracting or catastrophic conflicts by negotiating a buy-sell agreement, which stipulates what will happen to a partner’s share of the business should they eventually leave the business, whether that be voluntarily or involuntarily. Buy-sell agreements involve complex legal issues, including triggering events, funding provisions, valuation methods, and payment terms. As such, preventing further disputes through a buy-sell agreement requires experienced legal advice and counsel. Turn to a knowledgeable business lawyer from Patrick, Harper, & Dixon to discuss the suitability of a buy-sell agreement for your company and assistance in drafting an effective agreement that best protects your business.
Understanding Buy-Sell Agreements
In a closely held business, such as a partnership, limited liability company, or a small corporation, owners may negotiate buy-sell agreements to govern the transfer of ownership interests in specific situations. Buy-sell agreements frequently determine the transfer of ownership during significant events such as a business partner’s death, retirement, resignation, or divorce. Buy-sell agreements usually require a departing business partner to offer their ownership interests to the other partners or the business, which cashes the departing partner out of their stake.
Buy-sell agreements outline the conditions under which the business must buy an owner’s interest, or the owner must sell their interest to their business partners or the company. Agreements also govern the process of valuing the departing owner’s interest to determine the amount of consideration for the transaction.
In many cases, buy-sell agreements work together with insurance policies to help fund the buyout of a partner’s interest following their death.
Types of Buy-Sell Agreements
Business partners may negotiate various types of buy-sell agreements, such as:
- Cross-purchase agreements: In a cross-purchase agreement, a business’s remaining partners must buy a departing partner’s ownership interest.
- Redemption agreements: A redemption agreement requires the business to “buy” or cash out a departing partner’s interests.
- Hybrid agreements: Also called “wait-and-see” agreements, hybrid agreements combine features of cross-purchase and redemption agreements. Hybrid agreements may give a business’s remaining partners the first right to purchase a departing partner’s interests, with the business having an obligation to complete the buyout to the extent the remaining partners do not buy the departing partner’s equity.
Key Components of a Buy-Sell Agreement
A buy-sell agreement should incorporate various provisions to ensure the agreement adequately governs the transfer of ownership interests among business partners. Critical components of a buy-sell agreement include:
- Triggering events: Buy-sell agreements should outline the specific events that trigger the agreement, such as a partner’s expulsion, resignation, retirement, divorce, or death
- Valuation method(s): A buy-sell agreement can govern the process of valuing the business and, by extension, the departing partner’s ownership interest. For example, it can require the use of book value, market value, or income approaches or allow the parties to use expert appraisers to determine the business’s value.
- Funding mechanism: Buy-sell agreements can provide specific funding sources for the buyout of a departing partner’s interest, such as life insurance benefits, funds retained by the business, or a required capital call from the remaining members.
- Transfer restrictions: A buy-sell agreement may include language restricting a partner’s ability to sell or transfer their ownership interests without their partners’ consent, such as transferring interests as part of an equitable division in a partner’s divorce.
- Payment terms: Buy-sell agreements can determine the conditions under which a business or the remaining partners must compensate the departing partner for their ownership interest, including whether payment must occur in a lump sum or installments and the schedule of installment payments.
Benefits of a Buy-Sell Agreement
Buy-sell agreements can benefit companies in various ways, including:
- Facilitating efficient transitions of ownership interests when partners depart the business
- Protecting partners’ heirs/beneficiaries by providing a mechanism for them to cash out their loved one’s ownership interest
- Preventing financial or management disputes among owners when one partner leaves the business
- Maintaining efficient management of the business through ensuring stability in ownership
Common Challenges in Buy-Sell Agreements
Business partners can run into various pitfalls when negotiating buy-sell agreements, such as:
- Ambiguous/unclear valuation methods: Business partners can have legal disputes after a buy-sell agreement triggers if the agreement does not provide an adequate method for determining the value of the business and the departing partner’s ownership interest.
- Inadequate funding: A buy-sell agreement can fail if the agreement or business fails to provide the necessary funding for a departing partner’s buyout, such as a life insurance policy, a cash reserve, or a capital call requirement for the remaining partners.
- Lack of review/revision: As a business grows and evolves, its buy-sell agreement can become out-of-date or irrelevant, leading to complex issues when a partner’s departure from the company triggers the agreement.
- Insufficient enforcement mechanisms: A buy-sell agreement can fail its purpose if it lacks provisions requiring the business or its partners to fulfill their obligations, such as requiring remaining partners to contribute to capital calls to fund the buyout of a departing partner’s ownership stake.
Why Choose Patrick, Harper, & Dixon?
A buy-sell agreement may become one of the most important contracts you negotiate in your career. Choosing experienced legal counsel can help you protect your rights and interests. When you choose Patrick, Harper & Dixon, you can expect trusted advocacy focused on pursuing your needs and best interests. Our attorneys will take the time to explain your options and answer your questions. Our team will collaborate with you to develop a legal strategy tailored to your objectives and preferences. We will help you understand the best path forward and walk with you each step of the way.
Contact Us Today for Help with Your Buy-Sell Agreement
The best way to protect the business you’ve worked so hard to build is to prepare in advance for contingencies like the departure of a partner. Contact Patrick, Harper & Dixon today for a confidential consultation with a business attorney to learn more about what to expect in buy-sell agreements and how we can assist with your transaction.
