One of the best values a business transactions lawyer can provide to a client is advice on the end game: the breakup.
It’s inevitable, and yet, surprisingly few startup businesses have the end in mind as they begin a new venture.
If you think about it, though, this is not such a big surprise.
Entrepreneurs are natural risk-takers and positive thinkers. If they worried about all of the potential downside to the business, they might never take the next step.
But this is where the more risk-averse and pessimistic transactions lawyer can put “worst-case-scenario” logic to good use by asking the right questions and forcing the client to think about what happens if their business partner comes to them and says they want out of the business?
What if they demand that you buy their interest in the company? What can you do if they demand an exorbitant amount and you can’t pay it?
Once the client’s interest is piqued, the lawyer should then explain that a simple “buy-sell” provision, strategically placed, can prevent a lot of headaches down the road.
In plain English, the lawyer can explain these types of provisions can be set forth in a stand-alone buy-sell agreement or, more commonly, they are part of an operating agreement for an LLC or a shareholders’ agreement for a corporation.
“Buy-sell” describes the purpose –– to provide for situations when an owner can buy interest or sell interest in the business.
The goal is to have a straightforward plan so there is minimal disturbance in the business if a situation occurs.
In an agreement with buy-sell provisions, if one business partner wants to be bought out, it’s a simple process of following the steps in the agreement.
Here are some of the more common steps:
• If a business partner wants to leave the business, they must give notice to all the other owners.
• The other owners have a certain time period to decide whether they want to buy the leaving partner’s interest in the business.
• The purchase price for the leaving partner’s interest is already determined in the buy-sell provisions.
• The payment terms also are already determined and they can include payment of the purchase price over time.
• If the other owners decide not to buy the leaving partner’s interest, then the leaving partner is free to sell outside the business.
• If the leaving partner cannot find someone outside of the business to buy their interest, then the leaving partner remains an owner.
The purchase price can be set in the provisions, it can be determined using a defined formula (such as a multiple of EBIDTA) or it can be required to be determined by a certified business appraiser.
In any event, the purchase price is provided for in the provisions and there need be no further negotiation on the matter.
The same is true for the payment terms. If an owner wants to pay the purchase price and buy the leaving partner’s interest in the business, then the payment terms are predetermined.
Usually, the terms provide that a certain amount is paid up front and the remainder is paid over time. A promissory note is required to document the unpaid balance.
Of course, the full purchase price can be paid at any time.
The result is the leaving partner walks away from the business and receives the purchase price, either in full or in payments over time.
The remaining owners stay in the business and carry on without the leaving partner.
The goal of the buy-sell provisions is to have as little impact on the business as possible by providing a clear path forward.
It’s good advice to explain the benefits to the client of having a buy-sell provision in place long before they think they’ll need it.
When a partner starts having thoughts of leaving the business, it is too late to put these provisions in place.
Most business owners want to maximize the purchase price of their interest and therefore tend to overestimate the value of the business, demanding a sum so large that the remaining owners can’t afford to buy it.
Usually, the owners are emotionally involved and have a hard time being objective and pragmatic in these situations.
Having buy-sell provisions in place avoids the difficulty of negotiating all of the terms during a period when emotions are likely running high.
Buy-sell provisions also usually cover situations involving an owner’s death, divorce, disability, personal bankruptcy, retirement or termination of employment.
In those situations, that owner’s interest in the business may need to be transferred. The buy-sell provisions again step in to provide straightforward steps to deal with it.
Advising clients to have buy-sell provisions in place is important for new and existing businesses.
Ideally, it’s put in place when the business is started, but it is never too late for existing businesses to prepare an agreement.
Business owners should consider it a proactive step that can help eliminate potential problems in the future.
Laurie Lee is the owner of Elevate Business Law. Kathy Hartland is a professor at Florida Coastal School of Law.