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What would happen to
your business if your business partner died, divorced or retired? How would you
protect the business from an unknown third-party becoming your new business
partner? How would you prevent a bitter ex-spouse of your partner from becoming
your new partner after a divorce? If you wanted to buy-out the departing partner,
what would the price be? Are you convinced that you and your partner would
readily agree on the purchase price? What would the source of funds be for
buying out your partner? A well-drafted buy-sell agreement can effectively resolve
these issues without the enormous costs of a court battle.
A
buy-sell agreement (also known as a shareholder agreement or a member control
agreement) regulates the transfer of business ownership. First, it generally
prohibits transfers that are not approved by all of the owners. This prevents undesirable
persons from becoming co-owners in the business. Second, the agreement provides
for efficient ownership transfer in the case of certain events such as death,
disability, divorce and retirement. If one of these events occurs, the remaining
owner and/or the business will typically have the legal option to buy-out the
departing owner for a defined period of
time. Frequently, in the case of death, the agreement will actually require the
remaining owner to purchase the deceased
owner’s shares. This helps to ensure that the financial needs of the deceased
owner’s family are met.
What is the Purchase Price of the Buy-Out?
In the event that a
buy-out event occurs (such as death or disability), the agreement will provide
a cost-efficient way to determine the purchase price. Typically, if the owners
have agreed on a purchase price at the annual shareholder meeting, that price would
be used for that business year. If the owners have not agreed on or cannot
agree on a purchase price, the agreement will have an appraisal process where
professional business appraisers determine the value of the shares to be
purchased. An out-ofcourt method for determining value is worth its weight in
gold because it avoids the enormous legal and accounting costs of valuation
litigation.
Suppose
the buy-out price is $500,000 or more. How will these amounts be paid without
financially crippling the business or its remaining owners? If an owner dies,
the entire buy-out price is normally paid in full at death because it is funded
by life insurance policies upon each of the owners. In cases of disability,
divorce, or retirement, the buyout price is often paid out over a number of
years from the normal cash flow of the business. The payment obligation is
usually evidenced by a promissory note. Repayment is secured by a guaranty and
a stock pledge agreement.
A
well-drafted buy-sell agreement is necessary in a business with two or more
owners. Without one, the success and value of the business is threatened by
costly and time-consuming legal disputes between owners about ownership
transfers and the value of the business. Koepke & Daniels provides ways to
protect businesses and their owners from these problems.
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