When two or more people want to co-own a business, the buy-sell agreement should be one of the first documents that is created. The buy-sell agreement determines what will happen if a co-owner wants to leave the business, retire, sell shares to someone else, dies or goes through a divorce.
In essence, it protects everyone’s interests by establishing the procedure for setting the value of the business and the terms of a buyout. And even though no one enters a relationship wanting to be jilted, it’s an important protection for all parties.
Once you’ve created a buy-sell agreement for your business, it’s vital that this document is first followed as written and second updated frequently to reflect the current value of the business.
If you don’t update the value of the business, the result can be devastating, especially if the business experiences exponential growth after the agreement is made. The buyout agreement could greatly overvalue the business, which could cause shares in the business to be tendered at prices that are so high that there is no ready market for them. The company may also experience liquidity issues when it must redeem shares at these prices. Conversely, if the business is valued unrealistically low, the terms of the buy-sell agreement could be sold at bargain basement prices and therefore ignored by attorneys and valuation professionals. Similarly, problems can arise if additional shareholders are brought into the business without following the agreement’s methodology to purchase shares.
A business owner is going through a divorce, and co-owns his business with three other individuals. The initial buy-sell agreement was signed in 1990, when only two co-owners were shareholders in the business. Since then, the two additional owners purchased shares. However, the buy-sell agreement was not updated, and it is uncertain if the other owners actually purchased shares in accordance with the methodology specified in the buy-sell agreement. To further complicate matters, the original buy-sell agreement set price parameters at such an outrageous level in an attempt to keep the value low, that attorneys and valuation professionals are essentially ignoring the terms of the buy-sell agreement. Because the buy-sell agreement wasn’t updated, it did not benefit the shareholders – and the result was a substantial amount of money spent with attorneys and business valuation professionals – far more than if the shareholders had agreed to periodic updates to the agreement.
Unfortunately, not every business relationship ends up happily ever after. By starting out with a business pre-nup, or buy-sell agreement, and keeping it up-to-date, you’ll be better able to ensure an orderly separation on both a professional and personal level.