Organizing a small business is a bit like getting married. At the outset of the venture, everyone is optimistic, and no one is thinking about what happens if the founders disagree on a fundamental issue about the direction of the business.
Many about-to-be newlyweds, acting on the advice of their attorneys, sign prenuptial agreements that specify how the couple’s assets will be divided and who will care for the children if the marriage ends in divorce. The counterpart for a small business is a buy-sell agreement, a contract that avoids fatal gridlock among the governing members of the company or partnership by specifying the situations in which one or more partners (or shareholders) can force one or more of the other partners (or shareholders) to sell their interest in the company.
The most important section of a buy-sell agreement is the provision that specifies the situations in which one or more shareholders (or partners) can require another partner or shareholder to sell his or her interest. This provision – usually called the “trigger” clause — must be drafted with care to ensure that all principals in the business understand the exact circumstances in which they can be forced to sell their interest in the business.
Cross-purchase or buy-sell
The next most important section of a buy-sell agreement is the provision that sets forth the mechanics of a mandatory sale and purchase. In a two-person business, one partner can simply purchase the interest of the other. Depending upon the nature of the business, the buy-sell agreement can also provide that the company will purchase the interest of the departing investor.
Setting a price
Many businesspeople who sign buy-sell agreements often forget a very important provision: setting the price for the interest being purchased. The price for the interest of the selling shareholder can be a fixed sum stated in the original agreement. Unfortunately, the value of the business may increase to a number far greater than the originally specified price, making that price very unfair to one of the parties. Many businesses ask the firm’s accountant to set the price at specified intervals, perhaps once every three to five years. A professional appraiser can also be hired to provide an estimate of the value of the company.
Any businessman who is considering drafting (or amending) a buy-sell agreement may wish to consult a knowledgeable business attorney for advice on the exact terms that should be included in the agreement.