What is a Buy-Sell Agreement for a San Diego Business?
For small businesses with only several owners, a buy-sell agreement establishes up front the terms and conditions under which owners can be bought out, and at what price and under what conditions. Buy-sell agreements are essential for closely-held and family-owned businesses. The issue is not about firing an owner or future animosity. Everyone hopes and expects the friendships and good feelings to continue.
What about a divorce? Do we want the spouse as an “owner” making decisions because the court awarded half ownership to the spouse? What about a personal bankruptcy? Do we want a bankruptcy receiver involved in our business, potentially liquidating assets? Many other potential problems exist. A buy-sell helps solve these problems and, if drafted correctly, helps to avoid surprises, feuding, litigation, and loss of productivity.
San Diego Businesses: The Basics of Buy-Sell Agreements
In general, how a buy-sell agreement is structured depends on what the owners want and what problems they are attempting to avoid. In all cases, the idea is that some owner is being “bought out” in some manner. There are many questions to consider such as who is purchasing, who can be allowed to purchase, who is limited as a possible owner, what are triggering events, can the purchase be demanded, and the like. As intimated above, “triggering events” include death, disability, retirement, the sale to a third party, bankruptcy, and divorce of an owner.
The purpose of a buy-sell agreement is to maintain the business and maintain the continuity of the ownership with at least some of the original/founding owners. When done properly, a buy-sell agreement also provides an easy transition for unexpected events. Most importantly, a buy-sell agreement avoids the possibility of dissolution and liquidation.
At the broadest level, there are four types of buy-sell agreements:
- Buy-sell where the company is buyer — often called an equity repurchase or redemption buy-sell agreement
- Owner purchase buy-sell agreement — the other owners will be the buyer
- Buyer to-be-determined buy-sell agreement — upon the triggering event, agreement gives flexibility with respect to who will buy the ownership interest; can allow for third-party — replacement — purchaser
- No-sell buy-sell agreement — no sale is allowed; the most common variant here is that ownership control remains with the surviving owners but non-voting interests go to heirs, successors, or assigns
San Diego Businesses: Valuation is Often Contentious
Many small companies and closely held companies avoid a buy-sell agreement because no one can agree on the formula for the price of the buy-out. Appraisal can be difficult, costly, and can arrive at different values because there are many valuation methods including book value, discounted liquidation value, discounted cash flow, capitalization of earnings, and sales multiple valuations. If the ownership interest is not a controlling interest (50% or more), then issues of discounting come into play. How to fund the buy-out also becomes a concern.
However, life, disability and business interruption insurance can resolve some of these potential problems, or a no-sell buy-sell agreement can be used. Even if the owners cannot agree on how to calculate the buy-out price, a buy-sell is still essential for all the reasons stated above.
San Diego Businesses: Contact San Diego Corporate Law
For further information, please contact Michael Leonard, Esq. of San Diego Corporate Law. Mr. Leonard has the experience to help you create and review any needed buy-sell agreement, create and assist in executing business contracts, and assist with any business-related matter. Contact Mr. Leonard by email or by calling (858) 483-9200.