Executive Summary: It is one of the more important agreements co-owners can enter when beginning a new business or continuing an old one.
It’s something small business partners may not want to talk about when they are involved in the excitement of the launch of a new venture, but it needs to be put on the table – and in writing as soon as possible.
It’s the buy-sell agreement and it’s in place if one owner wants out or is ready to retire? How much is her share of the business worth at that point? How is such an agreement worded?
Maryellen Goodlatte, a principal with the downtown Roanoke law firm of Glenn Feldmann Darby & Goodlatte, has worked with business owners over the years and says buy-sell agreements are underused documents that can save headaches down the road.
The agreement “establishes a relationship between the owners of a business,” says Goodlatte. Single business owners – such as limited liability companies (LLC) and S or C corporations – avoid some of the headaches, but firms with multiple owners from the start must look at the bigger picture. “Whenever you have more than one person [involved], the owners ought to seriously consider a buy-sell agreement,” says Goodlatte.
The pieces of such a document find their way into an operating agreement that governs the activity of a limited liability company. “A buy-sell sets out the expectations of the owners of a business – what happens if one of us wants to sell? What happens if one of us dies? Can I sell my stock or interest in the LLC to anyone I want? What happens if we just hate each other and want to separate? Can a former owner continue to be a stockholder?”
Goodlatte compares it to a prenuptial agreement that two people might sign before they marry, protecting assets acquired separately before taking legal vows. “A lot of business owners don’t think about the breakup when they enter into an agreement,” she says. “A little bit of foresight can save a whole lot of trouble down the road.”
Other considerations for partners might involve guidelines regarding trade secrets, the goodwill built by a business, and non-compete clauses. Goodlatte says the wording and reach of the buy-sell agreement can take many forms. A properly drafted non-compete is enforceable, but has to be “reasonable” in terms of its time, territory reach and duration.
Exit strategies like a buy-sell must be crafted based on the person laying it out: is he the owner leaving or the one staying? “At the end they’d like to get something back [and] get something for their investment.”
The partner staying, for instance, may be required to pay the principal leaving some agreed-to equity. The value of a business can be agreed to and updated periodically or an outside appraiser can be brought in to determine a figure.
Buy-sell insurance policies can be taken out to fund an agreement, but can only be used in the case of a partner’s death. That type of insurance can be expensive and is often something businesses “a bit more mature” can afford, according to Goodlatte.
With the life cycle of many business ventures getting smaller and smaller, buy-sell agreements, no matter what they look like, are a prudent option. “There really isn’t a one size fits all,” notes Goodlatte. “It goes back to the expectation of the owners. Without [an agreement in place] there is some jeopardy. It’s money well spent.”