When a business is owned by more than one individual, the owners never think about the death, disability, or divorce of an owner, or even that another owner might quit. How do you deal with these situations? If an owner dies, becomes disabled or quits, the other owner(s) traditionally do not like the idea of continuing to work hard to grow the business when that piece of growth goes to either the other owner’s family or to the other owner himself even though he or she quit the business. However, without a Buy-Sell Agreement, there is not much the surviving owner or owners can do under those circumstances. The other party does not have to sell his or her interest; thus, the need for a Buy-Sell Agreement. A Buy-Sell Agreement provides that if an owner dies, the other owner(s) or the company has the right to buy his or her interest. A good agreement will state how the price is determined, the terms of the purchase, the terms of any promissory note that might be issued, and the security agreement. However, from a business perspective, the death of an owner is the easiest to address. Insurance can be purchased on the owners to pay for any purchase price.
The other situations become harder. If someone becomes disabled, how do you define disability? When do the other owners have the right to buy him out? What are the terms? Is it paid out over 5 years? 10 years? What is the interest rate? Is it prime? Prime +1? Prime +2? Prime -1? How much of a down payment? Is there a “due on transfer” provision so if the company is sold all amounts due and owing under the promissory note will be paid at the time of sale?
What if an owner becomes divorced? Is that company ownership interest community property? If so, then the owner’s spouse has a right to an interest in the company, not just to cash but actually an ownership interest. It may not be the best situation or in the best interest of the company to find yourself in business with the ex-spouse of one of the owners. Thus, a good Buy-Sell Agreement provides for the spouse to sign the Agreement and agree to sell his or her interest if there is ever a divorce between the owner and his or her spouse.
In the event that the spouse of an owner dies and leaves all of his or her interest to someone other than the surviving spouse/owner, the Buy-Sell Agreement will be in place to protect the spouse/owner. For example, if the spouse of the owner was previously married and that spouse has children from a prior marriage, then, upon the non-owning spouse’s death, he or she may leave all property, including his or her community property interest in the business, if any, to his or her children. If that happens, the owning spouse, as well as the other owners, are now in business with the children of the deceased spouse (the stepchildren). Thus, you also need to provide that upon death, the business or the other owners have the right to buy from the estate of the non-owning spouse, the interest of a deceased spouse not involved in the business.
Probably the most difficult position is when an owner stops performing or quits working. If two or three people go into business and all of them are supposed to work in the business, a business is doomed to failure if one owner is perceived to be doing less than the other owners. Under those circumstances, the question is when did that owner quit, if at all? So, I always advise my client(s) in those situations to have employment agreements for the owners. Let’s determine how the owners get paid. A lot of business owners believe it is best not to take a salary and merely share in the profits. This can create a difficult relationship between the owners. In other words, if A, B and C are in business together and A works 2,000 hours, B works 2,000 hours, and C works 1,000 hours, their compensation should be different. It is only fair that the owners get paid for the work they perform, that payment comes out of the profits of the business, and only after all owners have been adequately compensated should the profits be shared. If this process is followed, then the owners that are working more, get more from the business, and hopefully, do not build resentment because the third owner is working less. On the other hand, if somebody quits, it is no longer fair, and the other owners should have the right to buy the interest of that owner. In some situations, you actually provide that if an owner quits prior to a certain date, the purchase price is subject to a discounted value. For example, if the business is valued at $600,000.00 without any discounts and someone quits prior to three (3) years after signing the agreement, and they own one-third of the business, then the value for one-third of the business would be $200,000.00. However, the agreement states that if someone quits before three (3) years, the buyers (the other owners) only have to pay seventy-five cents on the dollar, or $150,000.00 for his or her interest. When people go into business together, they go into business “together” and expect everyone to commit and for one of them to leave quickly without any notice isn’t fair to the other owners who made that same commitment.
Disclaimer:This information does not constitute the rendering of legal, accounting or other professional services by Pete Benenati or Benenati Law Firm, PC. This information is not intended to create or provide an attorney-client relationship. Although care is taken to present the material accurately, any implied or actual warranties as to any materials herein are hereby disclaimed along with any liability with respect thereto.