What happens if your business partner comes to you and says he wants out of the business? What if he demands that you buy his interest in the company? What can you do if he’s demanding an exorbitant amount and you can’t pay it?
These types of situations (and more) are handled in what we call “Buy-Sell” provisions. These types of provisions can be in a stand-alone Buy-Sell Agreement or more commonly, they are part of an Operating Agreement (for an LLC) or a Shareholders’ Agreement (for a corporation). The title “Buy-Sell” describes its purpose – to provide for those situations where an owner can buy interest or sell interest in the business. The goal is to have a straightforward plan already in place so that there is a minimal disturbance in the business if one of these situations occurs.
If you have an agreement with Buy-Sell provisions and your business partner says she wants to be bought out, it’s a simple process of following the steps in the agreement. Here are some of the more common steps we see in Buy-Sell provisions:
- If a business partner wants to leave the business, she must give notice to all of the other owners.
- The other owners have a certain time period to decide whether they want to buy the leaving partner’s interest in the business.
- The purchase price for the leaving partner’s interest is already determined in the Buy-Sell provisions.
- The payment terms are also already determined in the Buy-Sell provisions – and they can include payments of the purchase price over time.
- If the other owners decide not to buy the leaving partner’s interest in the business, then the leaving partner is free to sell her interest to someone outside of the business.
- If the leaving partner cannot find someone outside of the business to buy her interest, then the leaving partner remains as an owner of the business.
The purchase price can be set in the Buy-Sell provisions as a set price, or it can be determined using a defined formula (such as a multiple of EBIDTA), or it can be required to be determined by a certified business appraiser. In any event, the purchase price is provided for in the Buy-Sell provisions and there does not have to be any negotiations.
The same is true for the payment terms. If an owner wants to pay the purchase price and buy the leaving partner’s interest in the business, then the payment terms are pre-determined. Usually, the terms provide that a certain amount is paid upfront and the remainder is paid over time. A promissory note is required to document the unpaid balance. Of course, the full amount of the purchase price can be paid at any time.
The result is that the leaving partner walks away from the business and receives the purchase price, either in full or in payments over time. The remaining owners stay in the business and carry on without the leaving partner. The goal of the Buy-Sell provisions is to have as minimal impact on the business as possible by providing a clear path forward.
It’s good business practice to have Buy-Sell provisions in place long before you think you’ll need them. Once a business partner starts having thoughts of leaving the business, it is too late to put these provisions in place. Most business owners want to maximize the purchase price of their interest and therefore tend to overestimate the value of the business, demanding a sum so large that the remaining owners can’t afford to buy it. Usually, the owners are emotionally involved and have a hard time being objective and pragmatic in these situations. Having Buy-Sell provisions already in place avoids the difficulty of negotiating all of the terms during a period when emotions are likely running high.
Buy-Sell provisions also usually cover situations involving the:
- Death of an owner,
- Divorce of an owner (a spouse may have some rights to the business),
- Personal bankruptcy of an owner,
- Disability of an owner who provides services to the business,
- Retirement of an owner, and
- Termination of an owner as an employee.
In these situations, the ownership of that owner’s interest in the business may need to be transferred. The Buy-Sell provisions again step in to provide the straightforward steps to deal with it.
Having Buy-Sell provisions in place is important – for new businesses and existing businesses. Ideally, it’s put in place when the business is started, but it is not too late for existing businesses to get an agreement in place. Business owners should consider it one of those proactive steps that can help to eliminate potential problems in the future.