It is easy to get caught up in the euphoriaof starting a new business.Because of this, many business ownersoverlook the need to implementa plan to provide for the transfer ofownership upon the occurrence ofcertain triggering events such as thedeath, divorce, insolvency or disabilityof a co–owner.
The buy–sell agreementis designed to address these typesof triggering events by providingagreed–upon arrangements to take effect upon the occurrence ofsuch an event. Essentially, the buy–sell agreement controls when theowners can sell their interest, to whom they can sell and what pricewill be paid. Its purpose is to provide for the orderly transfer of ownershipbetween co–owners. The need for a buy–sell agreement stemsfrom the basic premise that, subject to securities law compliance, anowner’s interest in a business is freely transferable. Because of this, itis highly recommended that co–owners adopt a buy–sell agreementat the inception of a business or as soon as possible thereafter toavoid any unnecessary delay, disruption or litigation upon the occurrenceof a triggering event.
The motivations for entering into a buy–sell agreement canvary dramatically among co–owners. For one owner, the desire toprovide his or her estate with liquidity at his or her death may beof paramount concern; for another, the desire to prevent outsidersfrom becoming co–owners in the business may serve as his or herimpetus for entering into the agreement. Whatever the motivation,a properly drafted buy–sell agreement will provide methods (usuallythrough the use of appraisals) for determining the fair value of adeparting and/or deceased owner’s interest in the business.
However, the buy–sell agreement is not only concerned withthe value of the interest being acquired but also concerns itself withwho the interest may be transferred to. Some restrictions may berequired by law, as in the case of professional associations; however,other restrictions in the buy–sell agreement may be includedto prevent and/or restrict unrelated third parties from acquiring anownership interest in the business. This is often seen in situationsinvolving closely–held family businesses.
Why enter into a buy–sell agreement? Triggering events canpose significant problems for businesses and their owners whenproper planning for such contingencies has not been completed.For example, many closely–held businesses typically rely on activeparticipation in the business by a co–owner. When a co–owner’s employmentwith the business is terminated, the business will usuallywant to ensure that the terminated employee/owner no longer hasinvolvement or rights in the business. To accomplish this, buy–sellagreements typically identify termination of employment as a triggeringevent which requires a terminated owner to sell his or herinterest in the business to the remaining owners or the business itself.The disability of a co–owner presents similar concerns. Manytimes, smaller businesses cannot afford to continue compensating adisabled owner for an extended period of time, particularly in situationswhere the disabled owner’s active participation in the businessis essential.
Divorce also present an issue for co–owners of a business and maybe addressed by a buy–sell agreement. Under Texas law, communityproperty rights in the business may exist in a divorcing spouse. Assuch, a business and its owners may be forced to recognize the nonparticipatingspousal interest if properly drafted buy–sell provisionsare not in place. It is important to note that since provisions relatingto divorce may constitute partition and exchange agreements underTexas law, care should be taken to ensure the formalities requiredfor these types of agreements are met.
Another situation which gives rise to the need for a buy–sellagreement involves the bankruptcy or insolvency of a co–owner. Thebankruptcy or insolvency of a co–owner usually triggers the buy–sellprovisions of the agreement. While most business structures typicallyafford their owners protection in situations involving the insolvencyor bankruptcy of a fellow co–owner; a buy–sell agreement canhelp prevent a business from getting tied up in bankruptcy court.The agreement can also require a co–owner facing bankruptcy tonotify the other co–owners before filing thereby triggering the businessand its owners’ obligation to purchase the interest of the insolventor bankrupt co–owner.
Since the terms of the buy–sell agreement must be agreed uponby the parties, they are typically the result of negotiations amongthem. When negotiating, careful attention should be paid to a numberof factors such as: (1) income tax consequences; (2) need forliquidity (both by owners and the business); (3) tax objectives; (4)estate planning issues; (4) license requirements; (5) marketability ofownership interests; (6) fair value consideration; (7) orderly disposition;and (8) future sale positioning.
The buy–sell agreement is highly recommended in almost everysituation involving co–ownership of a business. Due to the natureand extent of the obligations associated with most buy–sell agreements,parties seeking to enter into these types of agreementsshould seek the advice of a legal and financial professional.
