Do You Need a Buyout Agreement?

A buyout agreement is an important tool to allow you to plan for the future of your business.

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A buyout agreement, also known as a buy-sell agreement, is a contract among co-owners of a business that addresses what happens when an owner leaves (voluntarily or involuntarily). While your situation might feel solid now, the future holds the possibilities of death, retirement, business relationships going sour, and other circumstances that will affect the ownership of the business. If you want your business to continue after an owner leaves, or you are interested in avoiding conflicts over the terms of an owner's departure, you should draft a buyout agreement.

Who Needs a Buyout Agreement?

No business is legally required to have a buyout agreement. However, most businesses benefit from an agreement, including sole proprietorships, partnerships, LLCs, and corporations. Buyout agreements are more common in multi-owner companies than single-owner companies, as a motivating factor in creating a buy-sell agreement is ensuring that a co-owner does not sell his interest to someone the other owners do not want to work with.

However, owners of sole proprietorships and single-member LLCs can also benefit from buyout agreements. The agreement can provide a process for third parties to purchase the company from the owner or the owner's estate, allowing the business to continue if the owner retires, becomes incapacitated, or dies.

The Terms of a Buyout Agreement

The buyout agreement includes details about what happens when an owner leaves the business. The law does not require any specific provisions, and the more you can include in the agreement, the better prepared you will be if an owner leaves. Common provisions in a buy-sell agreement include:

  • Withdrawal events: A withdrawal event is a change in the business that triggers a buyout (more below).
  • Who can purchase the departing owner's interest: Can anyone purchase the interest (and become an owner), or is this option limited to the business, current owners, and/or family members? If a third party can buy in, do the other owners have the right of first refusal? Do the current owners have to agree on the new owners?
  • Valuation of the interest: How much money will the departing owner (or the deceased owner's estate) receive for the ownership interest? In the agreement, you can specify a formula to calculate the value, state that you will bring in an appraiser, or allow the owners to agree on a value at the time of departure.
  • Payment terms: Does the buyer have to pay a lump sum, or will the business accept installment payments?

Withdrawal Events: Initiating the Buyout

A buyout agreement will list the events that will trigger a buyout, meaning an owner will leave the business and others will purchase the ownership interest or shares. These events might include:

  • Divorce: Following a divorce, an owner's spouse might acquire interest in the business. The buyout agreement can provide that the spouse will not be an owner unless the other owners agree, and if they do not agree, the owners will purchase the spouse's interest.
  • Personal bankruptcy or debt: When an owner files for bankruptcy or has a debt secured by the business, the owner might have to sell his interest in the business.
  • Death, disability, or incapacity: Your agreement might specify circumstances in which an owner is unfit to work, including physical or mental illness, incapacity, and death. Following death, the owner's estate will receive payment.
  • Retirement or resignation: Business owners might leave the business for many reasons, such as moving across the country, retiring from work, or simply losing interest in the business.
  • Offers from outsiders: Your agreement might allow owners to sell their interest to third parties, or the agreement might prohibit this.
  • Termination: The owners might have the option to expel an owner from the business by a majority or unanimous vote.

How to Draft and Update a Buyout Agreement

Your agreement can be a stand-alone agreement or part of another business document like a partnership agreement or an operating agreement. Often you will create the agreement soon after forming the company, or you might draft the agreement months or years later. You do not file the agreement with the state (as you do some business formation documents). All owners must review and sign the agreement. Provide all owners with a copy, and keep a copy on file with your company's records.

You should periodically review the document as your business grows and when you bring in new owners. When you update the agreement, have all the owners review and sign the updated document.

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