Do I need a Buy-Sell Agreement for my business?
If you own a business and have a partner, have you thought of putting a legally binding Buy-Sell Agreement in place?
It is probably the most crucial document you need to create as soon as possible.
Hopefully, you never need to use your Buy-Sell Agreement. However, if you do, you want to execute what’s important to you and your partner so that it saves time, money, and provides peace of mind once it’s put together.
Who needs a Buy-Sell Agreement?
The answer to this question is straightforward: any business that has two or more partners. To create an effective Buy-Sell Agreement, consider three key factors.
- First, it requires all the main parties to agree to it. That often takes time and discussion, so agree to start now.
- Secondly, where possible, try to formulate the Buy-Sell Agreement so that any loss is measurable and an insurance policy can cover any losses.
- Third, for the best Buy-Sell Agreement, put it together when emotions are low. Something I repeatedly observe in business is that when emotions are high, clear thinking and intelligence tend to be lower.
Buy-sell Agreement benefits
There are many situations when a Buy-Sell Agreement is a wise investment of time and energy. Perhaps the most obvious time is when starting a new business. Unfortunately, this seems the most obvious time, but it can also be the most demanding. The main reason it is so tricky is that it appears there are too many other, more pressing priorities, and it is challenging to reach an agreement. In addition, an attorney with the right qualifications is necessary to craft a comprehensive Buy-Sell Agreement. This involves creating a framework and then allocating sufficient time and incurring necessary costs to ensure it is written correctly.
Starting a new business
Here is an example of how not having a Buy-Sell Agreement led to the destruction of the business. The worst part? It was a waste of just over two years’ work for one entrepreneur and his friend.
In this case, Bill and his best friend Paul had known each other for over 14 years. Their kids play together all the time, and about once every 3 months or so, Bill and his wife go out to dinner with Paul and his partner and have a great night out.
Because of their friendship, when Bill said to Paul that they should go into business together, it seemed like a great idea. Paul had a secure job in Corporate America and had set aside money to manage the transition to owning a business. Regarding Bill, after working for 10 years for another business owner, he was ready for a change and to own and operate his own business. As Bill said, “to do it the right way.” Bill didn’t have much money, but he was willing to start the business if Paul could invest some money and get things going. The agreement was that once the business was up and running, Paul would leave his job and come and work with Bill.
Bill invests $100,000 to start the business.
So, Paul invested $100,000 to start the business, while Bill worked over 60 hours per week for two years to establish it. By the 23rd month, the business was profitable enough that Paul was earning a market salary.
However, what Bill and Paul didn’t discuss was whether and when Paul would get his money back. It’s now almost two years later, and unfortunately for Paul, his job in Corporate America has now gone away. Much to Bill’s surprise, Paul is now asking when he can reclaim his $100,000 to help start the business, as he needs it to live on until he finds a job.
This came as a surprise to Bill. That is, Bill was now telling Paul that he had been working in the business for two years at 60+ hours per week and had taken little to no salary. He also told Paul that he thought the original investment was worth about the same as the money Paul would have been paid as a fair salary for his skills, and so they are about equal.
A simple Buy-Sell Agreement would have led to the proper discussion with Bill and Paul. Unfortunately, that is no longer happening, as Paul is now threatening legal action to recover his money. That’s not the bad news. The bad news is that Bill claims he does not have the money.
Bringing in a new partner
In another situation where I was able to assist, Sue and her business partner, Graeme, had successfully established their business. They first launched the business in 2004, and despite the 2009 recession, it had since rebounded and was performing exceptionally well.
The business was doing so well that Sue thought it was a good idea to expand by bringing in another partner, Grace. She casually spoke with Graeme about the idea, and he initially said he did not have too strong an opinion but would give it some more thought. Sue misunderstood his comments. She thought Graee was approving of the idea. So, she moved quickly and made Grace an offer that included an equity or ownership interest in the partnership, as Grace had mentioned receiving an offer from a competitor.
Minimizing risks while maximizing opportunities
Business is about taking and minimizing risks as well as finding and maximizing opportunities. However, the Buy-Sell Agreement that Sue and Graeme had put together in 2005, when they thought their partnership would be successful, had not been looked at since then. Six years later, the business had changed and become much more valuable, but there was no agreement in place on how to value the business at its current market rate or fair market value, nor what terms should be offered to a new partner.
The result was that Graeme felt he was being pushed out, as Sue moved so quickly, and he did not think the business was ready to bring on a new partner. Rather than saying a straight ‘no’ to Sue when she first asked about bringing in another partner and would think about it, he meant ‘no’ but did not want to come straight out and say it. The tension of bringing in a new partner ultimately proved too much for the business, with Sue and Graeme each hiring an attorney to resolve the matter.
Suppose a business decides to bring in a new partner. In that case, it’s critical to have a Buy-Sell Agreement that not only addresses a fair way to value the business but also outlines what will happen in case an existing partner decides to leave, including any compensation.
Insurable risk
One strategy to consider when creating a Buy-Sell Agreement is to identify the risks that an insurance policy will cover. For example, a good insurance policy will provide a payout to the business if one of the partners dies. This money is now available to pay down a debt that could otherwise harm the business due to the death of a partner. It doesn’t replace the partner, but it provides the necessary funds to stabilize the business, allowing the remaining partner to continue operating while they look for a replacement.
How do you create a Buy-Sell Agreement?
A Buy-Sell Agreement is a legal document. Once all parties sign the document, it becomes binding. Because it is such an important document, get help from an attorney with the right qualifications. The right attorney can break down the details and ensure it is clear to all parties.
When choosing an attorney, ensure they specialize in the relevant area of law. Examples include estate planning and business law, including contract law.
A well-crafted Buy-Sell Agreement can be one of the best investments two business partners can make. Just like the seasons, a business is in constant motion and ever-changing due to new technologies, laws, taxes, education, the stress and strains of the world, and the economy, and so it goes. The goal of a good Buy-Sell Agreement is that it will be ready to service the business, regardless of the season in which the business finds itself.
If you’d like more information, please do not hesitate to contact me for a brief consultation. We’ll discuss your particular needs, what’s important to you, and make a plan for those first few steps.