Buy-Sell Agreements: Working for the Best and Planning for the Worst

Buy-Sell Agreements: Working for the Best and Planning for the Worst

However optimistic you are about the future of your business, the reality is at some point your business will either end or change hands. A thorough business plan takes this into consideration. The best-case scenario is after many years of success, your business partners or a successor will fund a comfortable retirement for you by purchasing your interest in the business. The worst-case scenarios generally involve death, disability, divorce, disagreement or bankruptcy of you or your business partners. From the best-case to the worst, both you and your business may benefit from having a Buy-Sell Agreement in place.

Buy-Sell Agreements are sometimes called “business pre-nups” because they serve a similar function to the agreements soon-to-be married couples enter into which direct how their assets would be divided upon their death or divorce. Buy-Sell Agreements are binding contracts which spell out who business owners can sell their interests to, on what terms, and how the price will be determined. When the business is going well, and all the owners are getting along, it is much easier to agree on equitable terms than when tensions are high at the time of a buy-out and parties have little incentive to negotiate fairly. By discussing issues in advance and setting the ground rules for what happens upon the occurrence of certain events, business owners can avoid future arguments and limit the potential for expensive litigation down the road.

Starting with the best-case scenario, a voluntary retirement from a successful business, Buy-Sell Agreements can help define an exit strategy and ownership succession. The value of a business is not always clear and can be calculated in different ways with a wide range of potential results. The Agreement can state which valuation method will be used for the exiting owner’s share of the Company. The Agreement can also help define the structure of the exit to minimize taxes or allow them to be paid over time. For business owners hoping to fund a large part of their retirement using these proceeds, not knowing their buy-out price or tax burdens in advance can seriously jeopardize their ability to plan for retirement. These Agreements also are helpful in getting owners to think about who their buyers may be. As the Baby Boomer generation is entering retirement age, there will be a lot of small business owners looking to sell, and the market for willing and able buyers may be strained. If a buyer must be found unexpectedly or on short notice, the purchase price will likely be much lower than the true value.

As great as you and your business partners may get along now, it is possible at some point business or personal disagreement will rise to the level where one of you will be forced to leave the business. Business owners may also unexpectedly exit the business for reasons like a desire to focus on their families, illness of themselves or a loved one, or moving out of the area. In these situations, you and the exiting owner may have different opinions about what fair buy-out prices and procedures would be. In the absence of an Agreement, these disagreements can escalate quickly and may result in litigation. By having the Agreement in place, the emotional impact of dispute and the tendency for people to believe they are being treated unfairly is checked by being able to look to an agreement everyone consented to beforehand for how the exit will take place.

Even if you and your business partners are lucky enough to always agree, events outside of your control, such as an owner’s death, divorce, disability or bankruptcy, can lead to uncertainty as to who ends up with control of the business. When an owner dies, his or her share passes to their heirs. This often results in the spouse or children of a deceased business partner either wanting to participate in the business or, more commonly, wanting their proportionate share of the business earnings without having to work for them. Divorce can lead to a similar situation, and a court may order the business interest divided between divorcing spouses. If a business owner becomes disabled and unable to contribute to the business, their interest may become a burden on the other owners. Buy-Sell Agreements also often contain provisions for what happens if an owner becomes involved in criminal activity or becomes mentally unstable. If a business partner goes bankrupt, potentially for reasons having nothing to do with your business, creditors may be able to pursue their business interest to pay off what they are owed. Each of these situations result in either an unwanted business partner or an unexpected party demanding the value of the interest they now possess. A Buy-Sell Agreement can give the remaining owners rights to force out owners who have become a liability or purchase interests at a determined price to prevent heirs, ex-spouses, or creditors from gaining control. These goals are often accomplished by terms which give the remaining owners the first option to purchase any interest transferred from an owner for a price determined in the agreement. The source of funding the buy-out can vary, but is often a life insurance policy, which ensures available funds to buy the interest from the owner’s heirs.

Whatever the future holds for you and your business, a Buy-Sell Agreement can help make sure you are prepared for it. If your business already has a Buy-Sell Agreement in place, it may be time to review the document to make sure you understand it and that it still meets the needs of your business. An Agreement drafted for a start-up may no longer suit a business which has grown or added new business partners.

 

LLC Operating Agreement – Do I Really Need One?

LLC Operating Agreement – Do I Really Need One?

As many people have learned, it is relatively easy to form a new limited liability company (LLC) these days. Often when new clients come in for business advice, they have already filed the Articles of Organization through the Wisconsin Department of Financial Institutions (www.wdfi.org). Sometimes they figured it out on their own, and other times another advisor, such as an accountant, helped them with the filing. All it takes is a credit card and a few minutes of time, and you too can have your very own LLC. These simple state filings are an important and necessary step in the business organization process. However, there is more that should be done to ensure that your business is properly organized!

One of the foundational documents that every LLC should have in place is an operating agreement. An operating agreement provides the basic rules of the road with respect to management and ownership of the company. Without a written operating agreement, the LLC and its members (members are the “owners” of an LLC) will be governed by the default statutory rules. For Wisconsin-based LLCs, those rules are found in Chapter 183 of the Wisconsin Statutes. No offense to our hardworking legislators, but would you really want to rely on the statutes to govern your relationship with your company and business partners?

Operating agreements range from the relatively simple to the extremely complex. The level of complexity depends on the nature of the business and the goals of the members. For example, a husband and wife forming an LLC usually need a straightforward operating agreement that spells out the basics about governance (like who can sign contracts on behalf of the LLC) and liability protections (helping ensure the members are not liable for the debts of the LLC). Typically, extensive rules governing transfers of ownership are not needed when just two spouses are involved. (That is what marital property agreements are for…a topic for another day.)

As soon as ownership of the LLC expands beyond one person and their spouse, it is extremely important to spell out the rules on who can own the LLC and under what terms. For example, if one member wants out of the LLC, will the other members have to buy their interest? At what price? What happens if one member dies or gets divorced? (Would you want to be in business with your partner’s kids or ex?) How will the owners handle a fundamental disagreement about the direction of the business? These are just a few of the questions and issues that an operating agreement should address.

Addressing these types of issues up-front, hopefully before there is a death, disability, divorce, or disagreement, may save both the business and the relationships between the members. While negotiating and drafting these agreements does take time and cost money, it is an investment in peace of mind and, hopefully, a way to avoid future litigation.

These same issues and concerns are present in business corporations, partnerships and even family cottage LLCs. And remember, even when the business owners are all family (or maybe especially when that is the case), addressing these issues up-front is better than losing those relationships or ending up in court

Pin It on Pinterest