A buy-sell agreement is an agreement among the owners of a business that typically restricts ownership while the owners are alive, identifies a process in the event of the death or disability of an owner and establishes a methodology for valuation. According to The Piedmont Group, only 46% of business owners have a buy-sell agreement in place. In my experience, approximately 80% of an owner’s net worth is attributable to their business, yet they do not have a written agreement dealing with fundamental principles of ownership. In this post, I discuss a few reasons why your business needs a buy-sell agreement.
1. In the Absence of an Agreement, Company Stock and Economic Interests in LLCs are Freely Transferable
Most businesses are closely held, which means that the identity of the owners is critical to current and future success. However, corporate stock – (i.e., S corporations) stock is freely transferable. Imagine a four-shareholder corporation or four-member limited liability company, where one of the shareholders/members transfers their shares/interest to a stranger. I suspect the other three shareholders/members would be quite angry in this situation.
However, a carefully drafted buy-sell, shareholder or LLC agreement will restrict the free transferability of shares and provide a right of first refusal to the other three shareholders to prevent such a transfer.
2. Death, Disability, or Termination of Employment of a Shareholder
In the event of the death or disability of a shareholder/member, a buy-sell agreement will detail a process for the company and/or the remaining owners to purchase the interest of the deceased or disable owner. Typically, insurance plays a major role in such a purchase. Business owners spend a great deal of time creating value for their business, but that value can evaporate in the event of a major life event of an owner without a buy-sell agreement.
In addition, a key employee may own an interest in the company. However, that ownership is typically dependent on remaining employed by the company. Without a buy-sell agreement, that employee will remain an owner even if their employment is terminated. A well drafted buy-sell agreement will provide for the forfeiture or buy-out of an employee’s ownership in the event of termination of employment.
3. Protection of Value
A well-thought-out buy-sell agreement will include a valuation methodology. In a previous post, I discussed buy-sell triggers and valuation (https://wabusinesslawblog.com/buy-sell-triggers-and-valuation-estate-of-collins-v-tabs-motors/). Typical valuation methodologies include: an appraisal process, “cut-and-choose”, fixed price or a formula valuation. During the process of creating the buy-sell agreement, we work with the business owners to help them determine an appropriate valuation methodology. Working through the methodology helps the owners understand their business better and provides a framework to protect that value for the future.
There are a host of reasons to have a buy-sell agreement. For the 54% of owners that do not have a buy-sell agreement, do not delay any further. Let us help you protect your business and enhance its value. In addition, if you have a buy-sell agreement, but it has not been updated in years, now is your time to get it updated. We would love to work with you. To learn more about buy-sell agreements and to establish one for your business, please contact Beresford Booth at email@example.com or by phone at (425) 776-4100.
* Buy-sell agreements are also called shareholder agreements, LLC Agreements or Operation Agreements.