Power of a Buy-Sell Agreement

Starting a Business? Do Not Underestimate the Power of a Buy-Sell Agreement

The importance of a buy-sell agreement or similar provisions in any joint venture, partnership, or shareholder arrangement cannot be overstated. The people or entities involved need the instructions for a “break-up” or any other change in ownership.  This agreement must be finalized and executed at a time when the parties are acting rationally without emotion and getting along with each other. Ideally, this happens when the parties are launching their enterprise.

The instructions in the buy-sell agreement provide liquidity, an exit process, and a path to make ownership changes in the joint venture. The instructions handle the “when” and the “how” if a dispute arises.

The answer to “when” considers involuntary and voluntary events.  The involuntary events include death, disability, divorce, and bankruptcy, and sometimes termination for cause. The voluntary events include a sale or other potential transfer of ownership interests. In either scenario, the parties are provided with an opportunity to control and decide when and who sits at the owners’ table.

The “how” instructions provide for a notice process and a valuation process. The notice process is self-explanatory but just as important as the valuation process. The valuation process involves a built-in mechanism to agree on a buy-out number or instructions for hiring outside professional(s) to provide that number. The instructions should require the parties to attempt to find consensus on an agreed value. If no consensus is reached, the instructions should provide a recognized accounting method such as using a multiplier of net (or gross) profits or one or more comparative business appraisals. The instructions should recognize the potential for a basic impasse among emotionally charged parties and provide a process by which an appraiser or accountant is designated or steps as to how one is selected.

In other words, a well-drafted buy-sell agreement that provides specific and detailed instructions can save countless hours and dollars. By taking these intentional and thoughtful steps now, business owners can avoid the unpleasantness of a messy, expensive break-up in the future.

Author: Chris A. Johnson is a shareholder at Reid & Hellyer, APC where he practices mergers and acquisitions as well as business transactional law.