Plan Ahead

Buyout agreements can be a safety net for you, your business and your family.

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Yes, breaking up is hard to do. But planning ahead can ease the pain. If you're in business with others, chances are the current co-ownership won't last forever. Lots of things can happen. You or a co-owner may:

  • Decide to move out of state to pursue a new line of work
  • Become physically or mentally disabled – or even die
  • Seek to buy out a co-owner's interest in the business, or
  • Want to sell to an outsider

What happens then? Will the transition proceed smoothly and fairly? Or will there be discord and possibly litigation? The answer may depend on how well you've planned for the future.

Certainly, during the sunny, optimistic days when you're putting the business together, it's hard to focus on breaking up. And it's equally difficult when the business is humming merrily along. But planning ahead can save a ton of grief for all involved.

To avoid anguishing problems, it makes sense for every business with two or more owners to put together a buyout agreement. This is true whether your business is set up as a partnership, a corporation or a limited liability company.

So what exactly is a buyout agreement? It's a binding contract that controls the buying and selling of ownership interests in your business. Importantly, it makes sure that you and your co-owners aren't forced to work with strangers or other people you won't get along with. It also helps makes sure that if a co-owner leaves the business, he or she will receive a reasonable cash settlement. Or if a co-owner dies, his or her heirs will be paid fairly.

Retaining control of a business

Two lawyers – Bethany Laurence and Anthony Mancuso – have written a superb book called Business Buyout Agreements. In it, they point out that the main purpose of a buy-sell agreement is to protect the rights of the remaining business owners when one owner departs, either voluntarily or involuntarily.

"The remaining owners," they say, "are allowed to decide whether an interest can be sold to an outsider or whether an ex-spouse or an heir should be allowed to keep their newly gained ownership interest."

To better understand this point, consider the following scenarios.

Scenario #1: Joe and Cindy form a small corporation. Each receives 50 percent of the corporate stock. They don't foresee problems down the road so they don't bother with a buy-sell agreement. A few years later, Joe and Cindy have a serious disagreement over how to expand the business. To avoid further hassles, Joe sells his shares to Albert, whom Cindy has never met. The two quickly reach an impasse on management issues and the business comes to a standstill.

Scenario #2: Joe and Cindy form a small corporation – and they wisely create a buyout agreement to deal with what happens if one of them wants to leave the business. A few years later when they disagree on how to expand, Joe decides to sell his shares. Albert offers to buy the shares for $10 each. The buy-sell agreement requires Joe to offer the shares to Cindy at the same price. Rather than share control of the business with a stranger, Cindy buys Joe's shares. The business continues to run smoothly and prosper.

A guaranteed buyer

Laurence and Mancuso also elaborate on another way a buyout agreement can help you:

"If you're moving out of state and want to sell your ownership interest, an agreement can compel the other owners to buy it from you – in effect providing a market for that ownership interest where one might not naturally exist.

"If you and your co-owners don't make that kind of agreement, there's no guarantee that you could ever get cash for your interest."

And a buyout agreement can also guarantee that your spouse and children get fairly compensated for your business interest if you die. Again, let's consider two scenarios:

Scenario #1: Norm, Betty and Phil form a small corporation, each receiving one-third of the shares. They neglect to sign a buy-sell agreement. Three years later, Norm dies unexpectedly. His wife and two children inherit his shares. They want to sell the shares to raise money for college and other living expenses but there's no real market out there. Betty and Phil buy the shares for a pittance.

Scenario #2: Norm, Betty and Phil set up their corporation and plan for the future by signing a buyout agreement. When Norm dies unexpectedly, the corporation is required to buy his shares from his wife and children. Under the formula set up in the buyout agreement, the corporation pays a total of $250,000 in five annual installments of $50,000 each. Norm's family is able live more comfortably.

As you can see, not only can a buyout agreement guarantee a buyer for a departing owner's interest; it can also provide a price (or a price formula) and a time schedule for payment. Sometimes the buyout of a deceased owner is funded by life insurance that the business pays for.

Timing is crucial

You want to create your buyout agreement before it's needed – especially before you know who will be most affected by it. That helps assure the agreement will be fair and reasonable. Ideally, you'd like to get the job done when you form your business, but it can be done later.

If you have a partnership, you can put the buyout terms into your written partnership agreement. If you have a corporation, you can put the buyout language in a pre-incorporation agreement or shareholder's agreement – or a separate buyout document. With a limited liability company, the logical place is the operating agreement.

The Laurence-Mancuso book is a great starting point for putting together a buyout agreement since it contains sample forms and digital files. Before the agreement gets signed, however, it's smart to have a lawyer look it over.



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