Understanding Buy-Sell Agreements
Buy-sell agreements are designed to address certain types of triggering events by providing pre-agreed arrangements to take effect upon the occurrence of such an event. Essentially, the buy-sell agreement controls when the owners can sell their interest, to whom they can sell and what price will be paid. Its purpose is to provide for the orderly transfer of ownership between co-owners.
The need for a buy-sell agreement stems from the basic premise that, subject to securities law compliance, an owner’s interest in a business is freely transferable. Because of this, it is highly recommended that co-owners adopt a buy-sell agreement at the inception of a business or as soon as possible thereafter to avoid any unnecessary delay, disruption or litigation upon the occurrence of a triggering event.
The motivations for entering into a buy-sell agreement can vary dramatically among co-owners. For one owner , the desire to provide his or her estate with liquidity at his or her death may be of paramount concern; for another, the desire to prevent outsiders from becoming co-owners in the business may serve as his or her impetus for entering into the agreement.
Whatever the motivation, a properly drafted buy-sell agreement will provide methods (usually through the use of appraisals) for determining the fair value of a departing and / or deceased owner’s interest in the business. However, the buy-sell agreement is not only concerned with the value of the interest being acquired but also concerns itself with who the interest may be transferred to. Some restrictions may be required by law, as in the case of professional associations; however, other restrictions in the buy-sell agreement may be included to prevent and / or restrict unrelated third parties from acquiring an ownership interest in the business. This is often seen in situations involving closely-held family businesses.
Why enter in to a buy-sell agreement? Triggering events can pose significant problems for businesses and their owners when proper planning for such contingencies has not been completed. For example, many closely-held businesses typically rely on active participation in the business by a co-owner. When a co-owners employment with the business is terminated, the business will usually want to ensure that the terminated employee/ owner no longer has involvement or rights in the business. To accomplish this, buy-sell agreement typically identify termination of employment as a triggering event which requires a terminated owner to sell his or her interest in the business to the remaining owners or the business itself.
The disability of a co-owner presents similar concerns. Many times, smaller businesses cannot afford to continue compensating a disabled owner for an extended period of time, particularly in situations where the disabled owner’s active participation in the business is essential. Divorce also present an issue for co-owners of a business and may be addressed by a buy-sell agreement.
Under Texas law, community property rights in the business may exist in a divorcing spouse. As such, a business and its owners may be forced to recognize the non-participating spousal interest if properly drafted buy-sell provisions are not in place. It is important to note that since provisions relating to divorce may constitute partition and exchange agreements under the Texas law, care should be taken to ensure the formalities required for these types of agreements are met.
Another situation which gives rise to the need for a buy-sell agreement involves the bankruptcy or insolvency of a co-owner. The bankruptcy or insolvency of a co-owner usually triggers the buy-sell provisions of the agreement. While most business structures typically afford their owners protection in situations involving the insolvency or bankruptcy of a fellow co-owner; a buy-sell agreement can help prevent a business from getting tied up in bankruptcy court. The agreement can also require a co-owner facing bankruptcy to notify the other co-owners before filing thereby triggering the business and its owners’ obligation to purchase the interest of the insolvent or bankrupt co-owner.
Since the terms of the buy-sell agreement must be agreed upon by the parties, they are typically the result of negotiations among them. When negotiating, careful attention should be paid to a number of factors such as: (1) income tax consequences; (2) need for liquidity (both by owners and business); (3) tax objectives; (4) estate planning issues; (5) marketability of ownership interest; (6) fair value consideration;(7)orderly disposition; and(8) future sale positioning.
The buy-sell agreement is highly recommended in almost every situation involving co-ownership of a business. Due to the nature and extent of the obligations associated with most buy-sell agreements, parties seeking to enter into these types of agreements should seek the advice of a legal and financial professional. For more information, call our Law Firm at (210) 222 - 2288 or 1-800-862-1260.
