Business Divorce and the Benefit of Buy-Sell Agreements

Despite the name, a buy-sell agreement (sometimes referred to as a shareholder agreement or cross purchase agreement) doesn’t directly pertain to buying and selling a business in the traditional sense. Co-owners of companies enter into these agreements in order to detail the terms and conditions for a buyout in the event of the death, disability, bankruptcy, retirement, or even divorce. In other words, business owners are often advised to enter into a buy-sell agreement so that the parties can agree ahead of time regarding the restrictions, terms and conditions of the sale of their ownership. When an owner desires to, or must give up his or her ownership and role in the business, each party has certain rights regarding when their interest in the company can be sold, to whom, and under what payment and purchase price terms.

The reasons for needing a buy-sell agreement, in the event of a death, disability, or retirement, seem obvious. However, there are less common situations that can arise during a company’s lifetime that could endanger owners’ interests or the business itself in the absence of a properly crafted buy-sell agreement. For example:

Bankruptcy. In the event of one owner’s personal bankruptcy, the entire business could potentially become tied up in bankruptcy court. In these situations, the company is sometimes liquidated, and then half of the assets claimed in order to cover the bankrupted owner’s debts. A buy-sell agreement could require owners to notify one another before filing bankruptcy. As a result, the buy-sell agreement serves as an automatic offer to sell the bankrupt owner’s share in the company to the other owner(s).

Divorce. In some divorce situations, a co-owner’s former spouse can ask for partial ownership of the business. This often happens in community property states like California, because in most instances all earnings and property acquired during the marriage are considered owned equally by both spouses.

A buy-sell agreement can require soon-to-be ex-spouses of owners, who will gain partial ownership in the company through the divorce, to sell their interest in the company to the other owner(s). A well-crafted buy-sell agreement should provide a valuation method so that the purchase price is set before these situations ever transpire. Of course, it is much easier to agree on purchase terms and price before there is an event that creates acrimony.

Starting and operating a business with more than one owner is often referred to as a “business marriage.” Agreeing ahead of time regarding how to handle a “business divorce” will provide business owners with peace of mind relative to how to handle a stressful change of ownership. And, in most cases, also help to ensure the business can continue to operate free of court intervention. One could view these contracts as a “prenuptial agreement” for businesses. Co-owners of businesses should create buy-sell agreements from the moment a business is formed in order to protect each owner’s financial interests, the continuity of the business, as well as the interests of legal heirs.

For more information on buy-sell agreements and their various benefits, contact our business planning attorney for more information.

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