Why is a buy-sell agreement important?
Texas law does not require a buy-sell agreement. But without one, the remaining owners may have to deal with someone they did not expect to be co-owners. The chief problem addressed by a buy-sell agreement is what happens to the business ownership when an owner of a closely-held business quits, is fired, dies, gets divorced, or becomes bankrupt. It may be in the company’s best interest that the shareholder’s equity does not remain with that person, but instead, be transferred back to the other owners or the business. But that will not occur without a buy-sell agreement.
A buy-sell agreement protects the company from ownership interest being retained by a shareholder who is fired. It can also protect the business from shares of stock being distributed to beneficiaries upon the death of the shareholder, or a creditor if the shareholder declares bankruptcy.
A buy-sell agreement provides the company or its other owners to buy the departing owner’s stake in the company. This preserves the ownership of the company and continuing operations. A buy-sell agreement can be a separate agreement. But more often, it is included in a corporation’s shareholders’ agreement or a limited liability company’s operating agreement.
When does the company have the right to repurchase shares?
The most common events that a buy-sell agreement can address include:
Termination of Employment
Quits. If a shareholder quits, the company may want to buy back her shares upon that event.
Fired. If that shareholder is fired, the buy-sell agreement could require a lower purchase price.
Divorce. Texas law requires the just and equitable division of all marital property. To avoid an owner’s former spouse suddenly having a say in the company’s internal affairs, the buy-sell agreement could compel the divorced spouse to sell back any interest to the company or its other owners.
Bankruptcy. A buy-sell agreement can limit the risk posed by an individual owner filing for bankruptcy.
Death or Incapacity. A buy-sell agreement can include provisions that require selling the dead owner’s shares to the company.
How does a small business afford to buy back the shares?
There are three main methods that small businesses use to fund the buyback of shares.
Installment plan – The buy-sell agreement can specify that the payment for stock to the departing shareholder be made for a few years.
Sinking fund – This is a savings account that the business maintains to buy out the shares of a stockholder.
Insurance – A business can maintain insurance policies on its owners in the event of death or other specified circumstances, and the proceeds from the policy can fund the buyout.
How do you value the shares of a closely held business?
Another critical part of a buy-sell agreement is to create a way to determine the purchase price for the shares of the departing owner.
Third-Party Valuation. One method is to rely on a third-party expert’s valuation of the business. This way has the advantage that the estimate will probably be unbiased. It can also consider the distinctions that are ignored by the formula method described below.
EBITDA. A popular method is based on the earnings of the company, such as earnings before interest, taxes, depreciation, and amortization.
Waco business lawyer for a buy-sell agreement
Dunnam & Dunnam’s business attorneys can help you create a buy-sell agreement for your business. You should carefully discuss your options for a buy-sell agreement with an experienced Waco business attorney who can skillfully draft your agreement. Contact Dunnam & Dunnam at 254-753-6437.