6 Factors To Consider When Writing a Buy-Sell Agreement For Your Business
How To Write A Buyout Agreement For Your Business
Before you open the doors of your new business, many legal documents need to be written and discussed between you and your business partners. One of the most important documents is a buy-sell agreement. Even for a simple business, a buy-sell agreement can prevent future financial catastrophe.
What Is a Buy-Sell Agreement?
Sometimes called a buyout agreement, a buy-sell agreement is a legally binding contract between multiple business partners that determines what will happen to an ownership interest in case of certain circumstances. Those circumstances could include a significant life-changing event like death, divorce, retirement, or disability–or the buy-sell could apply under other circumstances, or even if one partner just decides to exit the business. This agreement can protect the business by preventing conflict or disputes between partners that can ruin a business and even leave its owners bankrupt.
Before You Begin Drafting a Buy-Sell Agreement
Before you and your business partners begin writing your buy-sell agreement, consult with your Scottsdale business attorney to discuss important topics such as these:
- Payment Schedule: Will the buyout be for a single cash payment, or a series of payments? Will there be interest? If so, what rate? If there will be multiple payments, can the buyer prepay the loan? Will there be security for the loan?
- Insurance: In many cases, when a life change prompts an exchange of business shares and a cash buyout payment is required, the biggest challenge is finding enough cash to fund a buyout of the partner. In that case, you and your business partners should discuss purchasing an insurance policy so you can get the money that would be needed.
- Objectives: It’s important that all parties are on the same page regarding both short and long term objectives for your business. If individual parties cannot agree on the objectives, it may not be a good idea to go into business together.
- Taxes: Everyone should fully understand all tax consequences in the event that business shares are later exchanged so that you save significant amounts of money if things are handled properly.
- Scenarios: Discuss best and worst case scenarios to make sure you have the right clauses that would protect against unexpected life events. Even the best relationships can go sour in these types of situations.
Once you’re prepared to start drafting a buy-sell agreement, consult with your Avondale business attorney and consider these six factors:
Factor #1: Determine What Events Trigger a Buyout
The most common events that trigger buy-sell commitments are major life changes such as retirement, death, divorce, disability, or failure of one party to meet their contractual obligations. Your agreement should clearly lay out the consequences of these events, assuring potential sellers that their shares will be purchased and that potential buyers won’t be forced into buying shares they are unable to afford.
Depending on your business and the situations of the partners, some events do not need to trigger a buy-sell commitment. For example, sometimes one partner will retain ownership even after retirement or will want to pass their shares to a surviving spouse or relative after death.
Factor #2: Discuss Common Buyout Clauses
Your Glendale business attorney will work with you and your business partners to discuss the most commonly used buyout clauses and will also make recommendations of clauses that may be relevant to your situation. These include:
- Wait-and-see: This clause commits business partners to a sale while deferring the specifics until a triggering event takes place. As long as the business partners trust each other, this flexibility can be very beneficial from a tax and ownership perspective.
- Shotgun clause: Owners commit to a specified share price in case one business owner wants to sell all of their shares and leave the business. This clause can protect the other business owners from a long, expensive court battle that can seriously damage the business.
- Drag-along provision: This clause binds together a minority owner and a majority owner in the potential sale of shares, protecting the majority shareholders from minority shareholders who might stop any deals.
- Tag-along provision: Commits majority owners to let minority owners join any deals that may be made, guaranteeing that minority owners get the same terms as the majority owner.
Factor #3: Choose the Right Buyer for Shares
If one specific shareholder is essential to business operation, the person who buys that shareholder’s interests must be capable of filling that role within the business. Especially in a family-owned business, it may be important to determine which business partners will hold voting or non-voting interests, so that control of the business stays with the people who can run the business effectively.
Factor #4: Set a Share Purchase Price
When it comes to the time to actually buy the shares from another business partner, choosing a purchase price can become a contentious process. Written procedures discussed with your Chandler business lawyer can make sure that price disputes are quickly settled. Some options include agreeing annually to predetermined purchase prices or agreeing to abide by a price set by a third party, such as an arbitrator or appraiser.
Factor #5: Adopt Balanced Buyout Terms
Even after a purchase price has been settled, payment defaults are not uncommon. It’s essential to discuss reasonable interest rates, down payment amounts, buyout periods, terms regarding low cash flow, and security guarantees. These types of situations are where clear objectives can be especially important.
Factor #6: Select a Structure Free of Tax Surprises
The last thing you want after the sale of shares is an unexpected, expensive tax bill. Discuss with your Phoenix business attorney which corporate structure is best for your company so you can avoid surprises at tax time.
Get Legal Help with your Buy-Sell Agreement
Writing buy-sell agreements can mean a lot of difficult conversations and complicated scenarios, but doing the work before starting your business will provide security for your business and partners. When you work with the experienced attorneys at Denton Peterson Dunn, you can feel confident that you will receive the guidance you need to draft an effective buy-sell agreement to protect your new business. Contact us today to get the legal advice you need for your business documents!