Do you need to review and update your company’s buy-sell agreement to protect you and fellow owners in the case of a divorce, emergency, bankruptcy, incapacitation or death or one of your owners, shareholders or members?  What are some of the triggering events which should be included in your buy-sell agreement and what are some of the important issues which should be addressed?

Key Takeaways When You Review and Update Your Company’s Buy-Sell Agreement

• The buy-sell agreement specifies the process for handling ownership and investment interests when specific “triggers” occur in the life of any owner or investor in the company.
• An effective buy-sell agreement should establish who can buy or sell an interest, how the interest is to be valued, specific events that trigger the buy-sell agreement, and how the event will be funded
• A well-structured buy-sell agreement prevents disputes and litigation, protects the interests of owners and investors and ensures the company’s stability and continuity

Why is the Buy Sell Agreement Such an Important Portion of Your Corporate Documents?

The reason to review and update your company’s buy-sell agreement is straight forward: things change, unexpected events happen, and the company needs to be able to survive any unfortunate event.

Unfortunately, many new businesses either use a boilerplate buy-sell contract, or fail to implement the agreement altogether.  An effective buy sell agreement protects all owners of a company while ensuring the preservation of the company itself in the event of a serious legal or catastrophic health event for one or more of it’s owners.  This is why it is so important to review your company’s buy sell agreement on a regular basis.  Your buy sell agreement should specify what happens if a “triggering event” occurs and the process for managing the transition of an owner’s stake or position within the company and associated decision making

Triggering Events in an Effective Buy Sell Agreement

The central triggering events which are covered in an effective buy sell agreement include the death of an owner, incapacitation as a result of an accident or health emergency, or valuation in the event of a legal issue such as a divorce or bankruptcy for an owner, shareholder, member or investor.  This important agreement should provide specific details on how ownership interests or shares will be transferred or bought out in the event of a triggering event as well as how the value of the shares or ownership interest will be established.  A “cross-purchase” agreement might establish the right and process of remaining owners to buy out the affected party’s interest in the company.  Specific provisions such as a right of first refusal or the right to approve any associated sale are often sound strategies.

Pro-Tip: “If you have a company, and let’s say there’s three or five people that are members in this LLC, life happens, unfortunately, people die, they become incapacitated, they get divorced, they file personal bankruptcy. So why is it important to address what happens in those events upfront? Because it doesn’t cost that much money and we already have customizable buy-sell agreements in our proprietary contract library. And not only do we automatically do it for you, we go through it and we go through it with the areas that are important for you to think about and to know and make choices on and, if you have questions, provide an explanation. And so when this happens, which you never think it could happen, you’ll remember that, oh yeah, we do have a clause for what happens if Uncle Joe can’t participate anymore.

And it’s in there and it’s a long document, but it’s in there, it’s there for you. It’s a framework and it gives you guidance on what are the steps you should take? How are we going to value that person’s interest? How are we going to transact that interest, who gets the first shot at buying them out? Does the company buy their share back? A lot of what ifs. And you can’t account for every possible what if on the planet, but there are 95%, 99% of the what ifs you may come across in your life that can be covered by your standard operating agreement and buy-sell agreement.

And if you don’t cover them up front, and now you’re three years down the road and making money and there are five of you and you’re rocking at it and boom, something happens. What’s the cost? What’s the disruption? What happens when the wheels come off if you don’t address it up front?

The short answer is: expensive disputes. If there’s a lot of money, there’s a lot of fights. And what do they say in the military? … failure to plan is a plan to fail. This is automatic. We talk you through these things. We improve your knowledge of how this works, and so when you’re having everyday discussions with people you do it with less stress and you’re prepared for a lot more than you would be had you just tried to form it yourself,

And when businesses are starting up, there’s an energy to that, right? There’s an excitement. We’re all pulling the same direction. Those conversations are a lot easier at that point than they are three or five years down the road. It really makes you feel good when you know you planned for a lot of things. Now you can focus on making money and it makes your company worth more money and as you go down the road.” – Dan Watkins, Founding Partner

Important Issues to Address in Your Company’s Buy Sell Agreement

The most important issues to address during business formation, or when you review and update your company’s buy-sell agreement are the process to determine the value of the shares or ownership interests at stake, as well as refunding or cross-purchase requirements after a trigger event.  It is also important to consider what will happen if one or more of the remaining owners are unable to contribute required funding.

Valuation may be established by any of several available strategies which should be tailored to your unique company and situation.  This can include but is not limited to “fair market value,” appraisal, book value or calculations based upon a number of factors.  It may also be valuable to establish an annual valuation of the company and require ownership to sign the annual valuation certificate which would be a tool in the process of valuation during a triggering event.

Do you need to review and update your company’s buy-sell agreement and other important corporate documents? We invite you to review our podcast Episode 2 – Corporate Documents, Contracts, and Raising Investment Capital as well as the strong recommendations of our clients and contact the Watkins Firm or call 858-535-1511 for a complimentary consultation today.