The Legal Considerations of Buy-Sell Agreements
A buy-sell agreement, also known as a buyout agreement, is a legal contract between multiple owners of a business. Buy-sell agreement can apply to various business forms, including partnerships, limited liability companies, and corporations. In a buy-sell agreement, business owners agree on the conditions—and sometimes the requirement—that one or more other owner’s share in the business can be purchased. Buy-sell agreements can be useful to avoid deadlock between co-owners and to ensure a smooth transition in the event of death, divorce and retirement. A good buy-sell agreement should be not only enforceable, but forward looking, anticipating and planning for future events that may arise in a business sometimes called “trigger” events.
Consider what events will trigger the substantive provisions of the buy-sell agreement. Some triggering events may be a retirement, death, divorce, or disability of a co-owner of the business. Buy-sell provisions can be custom-tailored for the specific needs and preferences of the business owners involved. For example, a buy-sell agreement can specify what constitutes a disability and for how long a co-owner must be disabled before the buy-sell provisions take effect and the disabled individual must sell his or her ownership interest in the company. It is a good idea to speak with a Mesa business law attorney about best practices and your specific needs in order to get a buy-sell agreement that fits your business. What works for one business may be all wrong for another business.
A central consideration in a buy-sell agreement is the amount of the buyout. Business owners generally agree in advance on a formula that makes sense well into the future to determine the buyout price. It could be a percentage of the average revenue or profit of the business. Or it could be based on the market value of the business at the time of the buyout. Generally, the buyout price may be paid over time to reduce the stress on the business. Tax considerations relating to the buyout price should also be taken into account.
Shotgun Buy-Sell Provision
In some buy-sell agreements, especially in businesses with two equal owners, it is a good idea to include a mechanism for one owner to leave the company on fair terms. A “shotgun” buy-sell provision allows one owner to force the other owner to either buy or sell the other’s interest in the business. To exercise this right, one owner proposes the specific terms to purchase the other owner’s interest. The other owner must either accept the terms and sell his or her interest, or buy out the initiating owner’s interest on the same terms. The result is usually a fair offer and a clean break between business owners. Without a similar mechanism, it can be very difficult for either business owner to leave (or get rid of) the other.
A non-compete agreement is a restrictive covenant that prohibits an owner who is being bought out from competing with the business. Naturally, this is designed to protect the business. On the other hand, individual business owners need to consider carefully whether they are willing to limit their options if they are bought out. Other post-buy-out restrictive covenants may make sense such as a prohibition on the solicitation of the clients, vendors or employees of the business, or a requirement to keep sensitive information about the business confidential. Restrictive covenants must be carefully drafted to be enforceable.
Transfer of Intellectual Property
Intellectual property rights should be considered in a buy-sell agreement. For most businesses, intellectual property rights, such as the right to use a name or logo, are extremely important. Sometimes, a business has also developed patent rights, which is the right to exclusive use of a particular product. In many cases, intellectual property rights are developed and held by individual business owners rather than the business itself. Thus, a buy-sell agreement could specify that the intellectual property rights of an owner being bought out are automatically transferred to the business.
Buy-sell agreements are important to maintain the smooth operation of a business, and to ensure that the business owners have a fair exit strategy. In order to get a buy-sell agreement that is right for you, your Phoenix business lawyer needs to have experience drafting buy-sell agreements, and your attorney needs to take the time to understand your specific needs and objectives.
Guest Blog By:
Denton Peterson P.C.
1930 N. Arboleda, Suite 200
Mesa, AZ 85213
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