To Avoid Various Potential Legal Disputes When Selling One’s Ownership Interest, it is Recommended to Develop a Buy-Sell Agreement
No one wants to think about leaving a business, particularly when it’s just getting started. But you should. Having a plan in place for when a business owner wants to sell his or her stake or when a business dispute arises can mean the difference between having a going concern or a defunct entity, in some circumstances.
It’s not uncommon for business owners to want to sell their interests, whether they are retiring or simply ready to cash out or there is a difference of opinion between co-owners. However, many startups and other small businesses fail to think ahead, which can lead to disputes over ownership rights, control and finances.
Benefits of a Buy-Sell Agreement
Buy-sell agreements can be stand-alone agreements or be contained within an operating agreement, partnership agreement or stockholders’ agreement.
In basic terms, a buy-sell agreement lays out an exit strategy for the owner-operator of a business. In addition to addressing what happens when an owner-operator wants to leave the business, it can also address a myriad of other events, including what happens when an owner-operator retires, dies, becomes incapacitated, or even gets divorced, or is failing to perform as intended.
When a “triggering event” occurs, the agreement gives the company or certain other owners the right to buy the departing owner’s interest. To help facilitate that process, the agreement details the price and terms of the buyout.
Terms of a Buy-Sell Agreement
While the specific terms of a buyout agreement should be tailored to your business, at minimum, the agreement should address the following issues:
Triggering Events: The agreement must set forth the circumstances that will trigger a buyout. In addition to an owner voluntarily leaving the company, other triggering events may include the personal bankruptcy of an owner-operator, the disability, death, or incapacity of a partner, or a divorce settlement in which an owner-operator’s ex-spouse stands to receive a partnership interest in the company.
Potential Buyers: The agreement should specify whether the remaining owners have an obligation, or simply the right, to buy out the departing owner. Similarly, it should also address who can buy the departing partner’s share of the business, i.e. other partners only or third-parties.
Valuation: One of the most important and complicated issues to address is how the departing partner’s interest in the partnership will be valued. The agreement should state whether an appraisal will be conducted or whether a specific valuation method will be employed, as well as the appropriate standard and basis of value to apply. The agreement should also specify what financial statements will be used, i.e. the date of the statement and whether it must be audited.
Timeline: To avoid disputes regarding how long the valuation and/or appraisal is taking, the agreement may establish reasonable timelines.
Terms of payment: If the departing owner will not be paid the purchase price in a lump sum, the buy-sell agreement should set forth the required down payment, installment terms, and any interest due.
Key Takeaway for New Jersey Businesses
Being unprepared for significant changes to your business can often lead to legal headaches. The departure of an owner is no exception. Whether you chose to include buy-sell provisions as part of a written partnership agreement or execute a separate agreement altogether, it is imperative to have a plan in place. For guidance, we recommend consulting with an experienced business attorney.
If you have questions, please contact us
If you have any questions or if you would like to discuss the matter further, please contact me, Jeff Cassin, or the Scarinci Hollenbeck attorney with whom you work, at 201-806-3364.
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