Buy-Sell Agreement

Good fences make good neighbors, and a road map for unwinding jointly owned ventures and for otherwise dealing with foreseeable contingencies — death, disability, retirement — is essential to the most modest of business undertakings. The issue is neither the dollar volume of the business, nor its value nor the number of its employees. The issue, rather, is the importance of the business to the financial stability of its owners. All business owners die. Many, indeed, a substantial minority, quarrel with their partners, and need a set of rules for resolving disputes and, if necessary, for ending the relationship.

Having said how important buy-sell agreements are to any business with more than one owner, the frustrating truth is that there are no well-drafted buy-sell agreements. Buy-sell agreements address problems for which there are no fair, all-purpose solutions. For example, in providing for the estate of a deceased owner to sell the interest to the surviving owner at fair market value, how is fair market value determined? Do you use an objective measure, such as a multiple of profits or revenue, or do you take account of the loss of services, expertise and contacts of the deceased owner? Fair market value, moreover, can mean different amounts for different purposes, even for a stable business that has not suffered the loss of a key person.

A buy-sell agreement might also trigger rights in the event of the disability or other departure of one of the owners. Who is to determine disability? Who is to determine that a departure has taken place in the case of quarreling owners who refuse to cooperate with each other? Settling on a useful buy-sell agreement requires selecting from a menu of less than satisfactory choices.

Here are some key issues, some typical provisions in a buy-sell agreement for dealing with those issues, and a critique of those solutions.

One owner wishes to sell out.

Solution: Right of first refusal in the non-selling owner.

Difficulties: Undermines marketability and can be used as a tool of harassment.

Owner deadlock over governance issues.

Solution: “Put-call” provisions, where one party names a per share price, and the other owner or owners have a right to buy or sell at that price.

Difficulties: “Death sentence” remedy may be too draconian for the dispute in question.

Death of an owner.

Solution: Either a put, the right of the estate to force either the company or the other owner to buy the interest, or an option entitling either the company or the surviving owner to buy the ownership interest of the deceased owner.

Difficulties: Valuation formulas, lack of liquidity (which, however, can be ameliorated by life insurance).

A co-owner quits or is disabled.

Solution: Trigger a shift in control, so the active owner can continue to run the business and make decisions.

Difficulties: Defining whether someone has quit or has been fired and whether a disability has occurred. Also, in the event of a disabled owner, there are no life insurance proceeds with which to purchase the interest, if that is what the parties agree to.