The Goals of the Business Buy-Sell Agreement

In our last article we discussed the primary goals of a buy-sell agreement.  To refresh your memory, they were (1) to restrict the transfer of a shareholder’s interest during his or her lifetime, and (2) to establish the value of the shares at the death of the shareholder.  In this article, we will try to round out the main objectives of a buy-sell agreement. Note: For purposes of the discussion in this article, we will discuss the buy-sell in terms of a corporation and its shareholders.  However, the principals apply as well to a partnership and its partners and to a limited liability company and its members.)

If the agreement is properly drafted, it will contain a formula for determining the value of the shareholder’s interest in the business.  But, this is only half the job.  The big benefit of a buy-sell agreement is that it provides a market for the shares by requiring a sale at certain triggering events, such as the death of the shareholder.  It may easily be taken for granted, but the fact that a market is created for the shares of a closely-held business could easily mean the difference between a surviving spouse closing the doors on the business and the spouse realizing the full value of that business.  

While the death of a shareholder is the primary triggering event, a buy-sell agreement can be designed to cover many other events.  For example, the disability of a principal shareholder would frequently put the business in jeopardy.  What would the future of a business be if the principal “sparkplug” for its success suddenly have an accident or illness that prevents his continued work in the business.  If properly planned, the buy-sell agreement can provide for the purchase of the disabled shareholder’s interest in the business in a way that fairly compensates him and gives the business the chance to find a new spark to continue the business.  

Suppose a business has multiple owners, each also an employee.  People being human and mortal, suppose further that at some time in the future the employment of one of the owner-employees is terminated.  Under normal circumstances, the other business owners would find it uncomfortable and ill-advised to have a terminated employee remain as an owner of the business.  Now, different rules for buying out the employee’s interest may apply, depending on the reason for the termination- for example, whether because of retirement, voluntary or involuntary termination, or termination for cause.  But, ways can be devised for the orderly transfer of the ex-employee’s business interest either to the business or to the remaining owners.

When a business is formed, the personal financial pictures of all of the owners are seldom the same.  Put another way, each partner has usually had his own previous financial history.  And, once the business is formed, things may change even further.  At some point, one of the shareholders may want to sell his shares, if only to make another investment.  One of the purposes of a well-designed buy-sell agreement is to provide for a right of first refusal on the part of the corporation and/or the other shareholders.  This right of first refusal protects the integrity of the business from outside interests and otherwise prevents outsider meddling in the business’s affairs.

Two other purposes should be noted.  When a couple divorces, the property settlement can often threaten the survival of a business.  A divorced spouse of a former owner sitting as an equal voice in the future of a closely-held business normally would do neither the spouse nor the business any good.  A buy-sell agreement triggered by the divorce of a shareholder can frequently save the business.   

Finally, the financial world being what it is, an owner of a small business can find that he is compelled to declare personal bankruptcy.  Bankruptcy can be defined as a triggering event where  shareholder-creditors may have rights to stock ownership or control.  Again, the future of the business can be rescued by the agreement.

Now that the many goals of a buy-sell agreement have been discussed, in our next article we will explore the alternative methods of designing the actual buy-out.

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Last modified: December 27, 2007

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