April 25, 2014
Authored by: Curtis Tiffany and Robert L. Newmark
A Buy-Sell agreement can be a useful planning tool for emerging companies as well as more stable, privately owned companies. In the context of an emerging company, the use of a Buy-Sell agreement provides a pathway for an orderly exit from the business by an owner if the owners do not see eye-to-eye with each other with respect to creative direction, allocation of responsibilities or other issues.
While these concerns also arise in more mature companies, such companies also face a host of other issues that can be addressed effectively in a Buy-Sell agreement, such as when an owner of a more mature business decides to retire from a business and wants to sell his or her ownership interest in the company. If an owner of a business decides to retire but has no agreement with the co-owners regarding what will happen to ownership interests in the company upon retirement, he or she may be left with few attractive options.
If a retiring owner holds a minority ownership interest in a company, it will likely be difficult to attract outside buyers for this interest and any potential buyers will demand a discount due to the minority position they would be buying into. There is also no guarantee that a retiring owner will be able to find an outside buyer for his or her ownership interest in the company, meaning that the retiring owner would be stuck holding an illiquid ownership interest in the company that may or may not provide income with which the retiring owner can fund his or her retirement. It is with these scenarios in mind that a properly crafted Buy-Sell agreement can help to ensure that the retiring owner will have the ability to “cash out” upon retirement. Most Buy-Sell agreements contemplate that the retiring owner could trigger a sale of the company as a whole, or cause the other owners to buy his or her ownership interest.
When is the best time to think about a Buy-Sell agreement? While each circumstance is different, generally, it is a good idea to engage in discussions regarding what will happen to the ownership interests held by each co-owner earlier rather than later. Owners may not look forward to discussing exit planning in advance, but it may be easier for co-owners to come to an even-handed agreement regarding how each will be treated if these conversations take place at a time when there are no immediate concerns regarding any owner’s exit or retirement. Putting off the discussion regarding exit planning until the time where one of the owners is thinking about retirement can provoke his or her co-owners into taking a more aggressive stance and may result in the retiring owner receiving less, in some cases substantially less, for his or her ownership interest in the company than he or she would have otherwise received if a Buy-Sell agreement were put in place at an earlier point in time.
See our sister blog, StartupBryanCave.com, for more blog posts regarding start-ups.