Do you know what will happen to your business if a co-owner partner dies?  If he gets divorced?  What if he decides he just wants to retire?  Will you receive 100% ownership of the business?  If he dies, will you have to share business interest and decision making power with his wife or children who do not know the industry?  If he gets divorced, will you have to share interest in the business with his now ex-wife?  How much money will you have to pay to get 100% ownership of the business?  If he retires, will you have to pay out disbursements to him for the work he put into the business over the years?  These questions, and many more, can be answered by what is called a buy/sell agreement.

WHAT IS A BUY/SELL AGREEMENT?

Some have referred to a buy/sell agreement as a pre-nuptial for your business because it functions similarly.  It will dictate how a person’s interest in a business can be bought if certain “triggering events” happen.  These triggering events can be just about whatever you want.  Most commonly, they are death, divorce, retirement, or disagreement among owners as to normal business operations (aka, deadlock).  Without a buy/sell agreement, you might not get a favorable outcome in these situations.  A buy/sell agreement can be its own separate document, or it can be part of your business’ operating agreement.   Let’s discuss some of the common trigger events.

Death of an Owner

If an owner dies and there is no provision in your buy/sell agreement stating what should happen to his share of the business, it will likely pass to his heirs – his wife or children.  An attorney can draft a buy/sell agreement to include provisions requiring the deceased’s heirs to sell the interest back to the other owners, thereby keeping the status quo of the business’ operations.  This will allow the business to continue to be run by owners who have intimate knowledge of the company’s operations and the industry.

If your business is a partnership or a sole proprietorship, a buy/sell agreement is particularly necessary.  For a partnership that does not have a buy/sell agreement, the business automatically dissolves upon the death of one partner.  An attorney can draft the buy/sell agreement to cover what will happen to the deceased partner’s interest upon death.  For a sole proprietorship that does not have a buy/sell agreement, the business will automatically pass to your heirs, if you have any.  If you do not have any heirs, there will be no one to run the business.  In this situation, an attorney can draft the buy/sell agreement to cover who can buy your business – family or a loyal employee – upon your death.

Divorce of an Owner

Similar to death of an owner, this triggering even could leave you with an unwanted or unplanned business co-owner.  Without a buy/sell agreement, if an owner gets divorced, the soon to be spouse could get that owner’s interest in the business through their divorce settlement.  The owner’s ex-spouse likely has no experience in the industry and may not have an ounce of business experience.  You and the other owners may simply not get along with this person.  Would you want them to have decision making power in your business? A buy/sell agreement could require the remaining owners to have the right of first refusal.  This means that the owners will have the option to buy that interest before it goes to the ex-spouse.  The buy/sell agreement could also have a provision that actually forces the ex to sell that interest back, either to the original owner or the other owners.

Retirement of an Owner

What if a co-owner wants to retire from the business?  What if you want to retire from the business?  Without a buy/sell agreement, there is nothing that will state if the remaining owners will have to buy out the retiree’s interest in the company.  A buy/sell agreement can dictate how the retiring owner should be paid for his interest in the business.  It can also determine how to value the retiree’s interest in the company.

Disagreement Among Owners on Normal Business Operations

Not just a tool for when one owner wishes to leave the business, a buy/sell agreement can be helpful to deal with situations of deadlock among the owners.  For example, if owners with equal interests in the company come to a point where they cannot agree on an issue, the business would likely not be able to continue normal operations.  This could lead to the dissolution of the business.  A buy/sell agreement would lay out how this dissolution would proceed and how the money is disbursed between owners.  In this type of situation, it is especially helpful to have a buy/sell agreement already in place.  After all, if the owners cannot come to an agreement on business operations, how are they going to come to an agreement on dissolution terms and the payout of money?

FUNDING A BUY SELL/AGREEMENT

Buying a co-owner’s interest in the business can often be costly, and most people simply do not have the money necessary just sitting in their bank account.  Because of this, buy/sell agreements are often funded by insurance policies.  Commonly, they are funded by life insurance policies (usually in instance of a sole proprietorship).  These policies can either be cross purchase plans and entity plans.  For a cross purchase plan, each owner buys a life insurance policy on each of the other owners.  The business does not own the policy.  Each owner lists the other owners as beneficiaries.  If one owner dies, the remaining owners will be paid as beneficiaries and then can purchase the deceased’s interest.

For entity plans, also called stock redemption plans depending on what entity your business is organized as, each owner enters into an agreement with the business.  The business owns and pays the life insurance premiums; it is also the beneficiary.  If an owner dies, the deceased’s interest is purchased from the estate by the entity and this interest is divided among the remaining owners.

As the business owner(s), you have the ability to pre-determine what will happen to your business in the above situations, which can result in piece of mind regarding the future of the business you have worked so hard to create.  Addressing these triggering events and the issues associated with them BEFORE they occur is the best way to avoid disputes in the future.  If you wait until after a situation arises, tensions are likely to be heightened and you’ll likely meet resistance from other owners.  This would lead to legal battles, which we all know means more monetary costs to you.

DISCLAIMER:  As always, this is just a general overview of this topic. Everyone’s situation is unique and may require additional and more in-depth information. Any information on this site is not legal advice and should not be construed as such. Additionally, all topics on this blog are relevant to Illinois law only.  Please be aware that the use of this site, including commenting on any blog articles, does not constitute an attorney client relationship. As such, no information sent through this website or posted on the comments section of this blog is not confidential and is not protected by attorney-client privilege. The protection of the attorney-client privilege will not exist until a retainer agreement has been signed.