Consider at the Outset
When business owners meet with their attorneys to discuss establishing a new business, they are usually looking forward to the great opportunities that lie ahead. The promise of immense profits, financial independence, and being their own boss is what the new business owners see. Nevertheless, one of the most significant issues that they should consider is an exit strategy, which is probably the last thing they usually are thinking about.
When lawyers bring up this issue with their business clients, whether they are start-ups or established businesses, they walk a fine line for various reasons. During the initial “dating/honeymoon” stage of a new
business venture, the owners rarely desire to think about the negative things such as the death or divorce of the business arrangement. Also, addressing such glum issues as disability, death, dispute resolution, spousal interference, and the possible failure of the business are not looked at as positive karma. Finally, the notion of paying an attorney to create one more document that they think will never be necessary is usually a pretty disagreeable thought to most business owners.
Possibly the most important document that the business lawyer often prepares for business clients is a buy-sell agreement. Unfortunately, this agreement is likewise one of the more difficult business documents to prepare accurately.
Important Functions of Buy-Sell Agreements
Buy-sell agreements serve many important functions. First of all, they restrict how the ownership interests, whether it’s stock, LLC membership interests, etc., can be transferred, thus preserving the close ownership of the entity. Second, they create a market for the ownership interests of the closely-held business. Third, the agreement provides the method for valuing the ownership interests. Fourth, in the case of an S-corporation, the agreement should provide protections from taking actions that may terminate the S election. Fifth, they can be used to allocate control of the business among the owners and management. Sixth, in the case of a limited liability company or an S Corporation, the buy-sell can provide a method to ensure that owners each receive enough annual distributions from business operations to at least pay the taxes that are attributed to them. And seventh, they can be utilized as an estate planning device.
Each function is very important to ensuring that owners of the venture have a road map for handling these issues before they arise and become serious problems. While most business owners do not like to address their mortality, permanent disability, termination of employment, and potential business disputes, it is simply easier to deal with them at the start before you actually have to confront them.
A buy-sell agreement gives business owners, the lawyers, and in serious cases where disputes are not able to be resolved by the parties, judges and juries, a framework for handling these difficult issues. The agreement also affords the parties an exit strategy in the event business issues can’t be resolved satisfactorily by the parties. Consequently, it serves as a type of “business prenuptial agreement” for the parties. Since we live in the litigious society, a buy-sell agreement won’t necessarily prevent litigation from occurring, but it will at least provide a mechanism for trying to resolve the issues.
So often, the need for a buy-sell agreement is not only a difficult concept to sell to the business start-up clients, but is also a challenging job for the owners and attorneys to properly execute together. However, the investment of effort and time is invaluable in providing a critical tool for assisting the business owners in their efforts to assure the successful operation of and exit strategies for their business.