Don’t Wait to Enter into a Buy-Sell Agreement

Posted on Monday, April 28th, 2014

Buy-sell agreements are so important that you should often incorporate buy-sell agreement terms into an LLC agreement, operating agreement, shareholder agreement or other agreement, to avoid the need for a secondary document and/or being without buy-sell agreement terms in place.

What is a buy-sell agreement? Essentially, a buy-sell agreement consists of a set of terms (agreed to by shareholders/members of a business entity, large or small) that provides for the orderly exit of one or more shareholders/members, under several different scenarios. For example, a buy-sell agreement can provide for an agreed upon path of resolution, shareholder/member exit, and the purchase of such exiting shareholder’s/member’s interest, if the shareholders/members are not in agreement on one or more fundamental business decisions (particularly useful for start-up, emerging, and high-growth companies), or if one shareholder/member decides to retire and wants to sell his/her interest.

This latter example of a shareholder/member that wants to retire or exit for various reasons is especially salient, and time sensitive when discussing buy-sell agreements. If, for example, a retiring shareholder/member of a business entity wants to sell some or all of his/her interest in a corporation or limited liability company, he/she may find that viable options are difficult to find (especially if such member holds a minority interest in the corporation/LLC). A potential buyer for such a minority interest may only be interested at a significant discount. Finding potential buyers for any interest in a privately held company is often difficult.

A properly drafted buy-sell agreement can help a company avoid litigation and help to ensure that an exiting member can cash-out successfully – without the problems of finding buyers or taking a valuation discount. A buy-sell agreement can trigger a sale of the business entity, or cause the owners (or sometimes the company) to buy a member’s interest when such member is contemplating an exit.

Many owners/investors are reticent to discuss buy-sell terms in advance or at the beginning of a business relationship. They shouldn’t be. Discussing these matters up front, or at least before a buy-sell agreement is needed, is generally easier than waiting until an imminent need for a buy-out is pending and the co-owners or other shareholders/members are not as open to discussions. Proceeding without a buy-sell agreement in place is rarely a good idea. For most parties, entering into a well-timed buy-sell agreement is good insurance, good for business relationships, and a best practice for shareholders/members of privately owned companies.