Whenever you have a partner or multiple owners in a business, one of the most important-but often overlooked-aspects of the relationship is planning for how it will end. It’s crucial that you come up with a clear exit strategy, and do so at the start of your relationship when things are going well, and not wait until you encounter problems down the road.
Indeed, the more thought you put into your exit plan ahead of time, the smoother things will be when one of you finally does move on. Formally documenting your exit strategy is done with what’s called a buy-sell agreement. A buy-sell agreement outlines exactly what would happen to the business in the event an owner leaves the company for any number of reasons, or when one of the owners die or becomes incapacitated.
Getting Clear On The What Ifs
When creating your buy-sell agreement, you need to consider all the ways you might potentially exit the business, and then outline what will happen to your ownership interests in each of those scenarios. For example, what would happen if you decide to retire and sell your stake in the company? Would you be able to sell to an outside party, or must you first give your partner the option to buy you out?
What if your partner gets divorced, and as a result, her former spouse becomes an owner of your business? What if one (or both) of you dies, or if one of you becomes incapacitated? What if you had to declare bankruptcy?
You need to get clear about all of these potential events, and address how they will impact the ownership of the business in the buy-sell agreement. Ultimately, your buy-sell agreement should proactively address any potential areas of conflict that could arise as a result of a partner’s departure, and minimize any disruption to your company’s operation or profits.
One of the most common areas of conflict is dealing with family members of a deceased or incapacitated partner. For example, should you or your partner die, the surviving partner will most likely not want to be in business with the spouse or children of the partner who died. To protect against that, you will need to put mechanisms within your buy-sell agreement that allow the surviving partner to buy out the incapacitated or deceased partner’s family. And not only do you need mechanisms in a buy-sell agreement for that buyout, but you need insurance or other sources of liquidity to fund the buyout.
Divorce is another area where conflict is likely. Should your partner’s former spouse be awarded a share of the company in a divorce settlement, you can tailor the terms of your buy-sell agreement to ensure the former spouse is compensated, so you aren’t stuck with him or her as a business partner or forced to pay an inflated price for their shares.
Valuation and Funding
An effective buy-sell agreement will not only detail how ownership of the company will be transferred should a triggering event occur, it will also spell out the methods that will be used to assess the value of the partner’s share and provide for where the funding for the purchase will come from. There are numerous ways to address valuation in your buy-sell agreement, such as using a set value that’s agreed-upon ahead of time, using a formula to determine value, or having an appraiser determine the fair market value.
As your Family Business Lawyer™, we can help you determine the optimal method for valuing your business, and then document the specific terms and conditions for executing the valuation into your buy-sell agreement. What’s more, we can put you in touch with business appraisers we trust to assist you once you are ready to get the sales process started.
Since purchasing a partner’s share of the company will require you to come up with a large sum of cash in a short period of time, it’s vital that you have a way to fund your buy-sell agreement. In most cases, the best way to fund your buy-sell is by purchasing insurance. For example, the company can purchase a life insurance policy on each of the owners, and the company would receive the death benefit to purchase the deceased owner’s share of the business and/or buy out the deceased’s heirs.
An alternate way to work the funding is to have each owner take out a life insurance policy on the other, and name themselves as the beneficiary. Upon the death of an owner, the surviving owner would receive the death benefit and use the money to buy out the deceased’s shares and/or heirs. In a business with more than two owners, rather than having each owner purchase a life insurance policy on each of the other owners, you can set up a trust to own the life insurance policies on behalf of the different owners.
Given all of the different variables involved and the fact that the very survival of your business is at stake, you should never rely on generic do-it-yourself (DIY) documents when you are documenting the terms of a business partnership or trying to create your buy-sell agreement. Always consult with an experienced attorney like us your Family Business Lawyer™ to ensure these essential agreements are properly created and all of the possible contingencies are accounted for.
Whether you need a new buy-sell agreement created or want us to review an existing agreement—even one drafted by another lawyer—meet with us your local Family Business Lawyer™. We will support you to not only create clear concise agreements, but also implement an agreement process that will allow you to more effectively navigate the inevitable changes that take place in the relationship while dealing with conflict in a way that’s both healthy and productive.
Finally, while creating a buy-sell agreement is an important way to protect your company in the event one of the owners decides to leave or if one of you dies or becomes incapacitated, such an agreement is merely one part of an effective estate plan. Given that your business is likely your family’s most valuable asset, you’ll want to consult with us to discuss the other legal protections you should have in place.
Whether it’s additional insurance, succession planning, different types of trusts, or all of the above, we can ensure the company and wealth you’ve worked so hard to build will survive—and thrive—no matter what. Contact us today to schedule an appointment.
This article is a service of Hector de Jesus, Family Business Lawyer™. We offer a complete spectrum of legal services for businesses and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer a LIFT Start-Up Session™ or a LIFT Audit for an ongoing business, which includes a review of all the legal, financial, and tax systems you need for your business. Call us today to schedule.