Business Blog: Before You Say "I Do" to Your Business Partner, Consider a Business "Prenup" - 5 Reasons You Need a Buy-Sell Agreement Today
By Julie E. Firestone & Elizabeth G. Yeargin on February 13, 2020
People often consider what can go wrong before exchanging their marriage vows. However, many do not address these same concerns when starting a company. What happens if your business partner unexpectedly passes away? Becomes permanently disabled? What do you do if your business partner wants to sell? You didn’t start your company to work with someone other than your partner, so the thought of running your business with your business partner’s spouse, child, or a complete stranger is daunting. So, how can you avoid this?
Here are five reasons why you should consider a Buy-Sell Agreement:
1. Clear Definitions of Triggering Events
You retain control by defining in advance which events trigger the implementation of a Buy-Sell Agreement. Early planning allows you to decide with your business partner which events are worth addressing and when a change in ownership may occur. Common triggers include:
- In the case of an owner’s death, the agreement can spell out the amount that will be due to surviving family members and when.
- If an owner has become disabled and can no longer run the business, he/she may need to be bought out to maintain the viability of the company.
- If an owner goes through a divorce, the owner can be required to sell out. This prevents the ex-spouse from becoming a partner in the venture.
- If a dispute cannot be settled between the owners, the friction and stalemate can hinder the continued performance and success of the business. Owners should consider whether a buyout in the case of such a dispute should be included in the Buy-Sell Agreement.
2. Certainty in Control
Without a Buy-Sell Agreement, a business owner can pass an ownership interest to anyone, from a spouse or child via their estate plan (or lack of a plan), to a creditor, or to a competitor. With a properly drafted Agreement, you may limit who can be an owner and when. For example, allow an owner to transfer the interest to a trust, but only so long as the original owner is in control of the trust. Or, provide the business and/or other owners with the mandatory right or right-of-first-refusal to buy the ownership interests from any departing owner, the estate of a deceased owner or the ex-spouse of a current or departed owner.
3. Identified and Ensured Sources of Funding
With a Buy-Sell Agreement in place, you can identify how and when to pay for the interest of the withdrawing partner. Options include purchasing life or disability insurance, determining whether the business has sufficient cash flow to pay a lump sum at the closing, establishing a line of credit to draw upon, or stretching payments out through periodic payments on a promissory note. The particulars for the payment of a buyout obligation depend solely upon what makes the most sense for your specific situation.
4. Established Fair Price
A Buy-Sell Agreement also allows you to establish a fair selling price for an owner’s interest in advance of any triggering event. By agreeing to the price in advance (or the method of valuation in advance), there is no negotiation or risk of a party being taken advantage of with a less than fair payout, for example, when one of the owners of a business passes away unexpectedly and must sell his/her portion of the business in short order.
5. Flexibility & Privacy
You have worked hard your whole life and you want to protect your loved ones throughout your life and estate planning. A well-drafted Buy-Sell Agreement allows you to title your interest in the business to a trust that will protect this asset from probate’s public eye. It may also allow you to name the trust as a beneficiary of your business interest upon your death. A Buy-Sell Agreement and a trust may also work together to ensure stable management of the business by the trustee if the owner becomes disabled or incapacitated.
Please contact Brouse McDowell for more information regarding drafting a Buy-Sell Agreement or succession planning for your business.