If you co-own a business with others, the day may come when either you or the other owners will find it desirable or necessary to leave the company. In the absence of a formal agreement, the exit of any owner could trigger potentially significant legal disputes over each owner’s rights and responsibilities and potentially hold the other owners and the company itself hostage to their demands. This is where having a comprehensive buy-sell agreement will prove vital. This contract, also known as a buyout agreement, sets forth the terms for a buyout and how other matters related to the departing member’s exit will be handled.
Drafting and executing an appropriate buy-sell agreement requires an understanding of not only Texas business law but of the unique dynamics and nature of your business. Having skilled legal counsel will greatly facilitate the future departure of owners while minimizing legal repercussions. Count on Capstone Legal Strategies to serve you and your organization.
What Is a Buy-Sell Agreement?
Owners of a business will, at some point, encounter significant life changes that could affect their interest in the business. They include divorce, disability, bankruptcy, and death. Or an owner might simply decide one day that they are no longer able to, or want to, remain an owner. These major life events could affect the rights of the other owners. For example, if an owner gets divorced, the spouse may seek to claim some portion of the owner’s interest in the business.
A buy-sell agreement is a contract among the owners that stipulates what happens if and when these significant changes occur. It can allow or require the owner in question to sell their interest, and thereby set the terms of sale. Agreeing ahead of time which events will require an owner to sell their interest, a method of valuing the business, and how the owner will be bought out will reduce the risk of costly and extensive litigation.
In sum, these contracts govern the following matters, among others:
- When owners can or must sell their interest in the company (a “triggering event”)
- To whom the interest may be sold, including to other owners or to third parties
- How to handle the death of an owner and dispense with their ownership interest
- The price that is to be paid for the departing owner’s interest, or a means of calculating it
Which Events May Trigger a Buy-Sell Agreement?
Specific events that may occur in the life of any owner may activate the buy-sell agreement. Examples include:
- Death: When an owner dies, another person will inherit their interest in the business. Naturally, the other owners may be averse to this because they never agreed to become co-owners with this individual. The buy-sell agreement can avoid this scenario by giving either the business or the surviving owners the right to buy the deceased owner’s interest.
- Disability or incapacity: A significant personal injury could leave an owner physically or mentally disabled and therefore unable to perform their ownership duties. The owner may even be incapacitated indefinitely. The buy-sell agreement should be drafted to allow the other owners or the company to purchase the owner’s interest.
- Divorce: Because Texas is a community property state, a divorcing owner’s spouse may have a right to claim some portion of the owner’s interest in the business. This could cause instability and legal complications that will disrupt operations. The owner can be required to sell their interest to the other owners in the event of a divorce.
- Bankruptcy: Ownership in a business is an asset, and as such, it must be addressed if the owner later files for bankruptcy. The business or the owners can buy out the ownership interest in this scenario. Doing so helps the company avoid becoming entangled in bankruptcy proceedings.
- Withdrawal from the business: At some point, an owner may want to leave the company for any number of personal or professional reasons. The value of the departing owner’s interest will need to be calculated so the other owners can effectuate a buyout.
- Internal disputes: Although your business will probably start off with amicable interpersonal relationships among the owners, these may deteriorate over time. These matters can also be addressed in a buy-sell agreement, including by establishing a method for the company to buy out certain owners’ interests.
What Should You Watch Out For in a Buy-Sell Agreement?
As a business owner, you should seriously consider signing a buy-sell agreement with your co-owners. These are some examples of contract terms to look out for:
- Triggering events: Make sure you understand what the triggering events are and how they might apply to you. You may wish to include additional events beyond the ones listed above to make the agreement as comprehensive as possible.
- Who buys out the interest: Usually the other owners will buy the departing owner’s interest, but there are situations in which a third party may be allowed to do so, or the company itself. If you are not comfortable with this you should object to including it or require that conditions be included.
- Valuation methods: Determining how to value the departing owner’s interest will, in turn, affect how much the remaining owners must pay. Whichever method is agreed upon, it should be clearly stated in the agreement.
- Funding buyouts: All owners should be prepared to fund a buyout when it becomes necessary or desirable to do so. There are different options such as insurance or funding a reserve account.
- Managing the exit: Leaving a business is a process, and much can happen during this time that can threaten ongoing operations. For instance, your business should consider requiring all owners to sign restrictive covenants such as non-compete, non-solicitation, and confidentiality agreements to help ensure anyone who leaves cannot harm your business.
Contact Our Houston Buy-Sell Agreements Attorney
When you retain Capstone Legal Strategies to assist with your buy-sell agreement, we get to work reviewing the details of how your business operates and the interpersonal relationships among the owners. Additionally, we examine existing operating agreements and other governing documents that may affect your buy-sell agreement. Finally, we draft a customized buy-sell contract that meets your needs and expectations and helps limit the risk of unwanted internal disputes and litigation.
Find out how we can serve you and your business today by calling us to schedule your confidential consultation.