Two people shaking hands over an agreement

Understanding Buy-Sell Agreements

William B. Hanley May 20, 2021

Businesses with more than one owner can face serious problems if one owner needs to leave the operation for whatever reason — unless there is a binding buy-sell agreement between the partners.

A buy-sell agreement is like a prenuptial agreement — it sets out the terms of the divorce, specifically, on how a departing owner can be bought out.

Co-owned businesses can face life-or-death shock waves if one owner suddenly decides to retire, becomes incapacitated, faces divorce or bankruptcy, or suddenly dies. Even with a buy-sell agreement in place, the other owners might be hard-pressed to honor the pact financially — and thus face the dissolution of the whole enterprise. Without a buy-sell agreement in place, internal bickering and indecision may set in.

If you’re involved in a messy ownership situation with your jointly operated business in or around Irvine, California, or anywhere in the counties of Orange, Los Angeles, or San Diego, contact William B. Hanley, Attorney at Law. Attorney William Hanley has 40-plus years of experience in business litigation to help you resolve your dilemma.

The Basics of a Buy-Sell Agreement

A buy-sell agreement is a binding contract between co-owners that spells out how owners can sell their interest, who can buy that interest, and at what terms and price. A buy-sell agreement also covers how co-owners (or the business itself) can buy out the stake of one of the departing co-owners.

There are different types of buy-sell agreements, including:

  • Traditional Cross-Purchase Plan: The remaining co-owners agree to buy out the departing (or deceased) owner’s share.

  • Entity Redemption Plan: The business itself buys out the departing owner and the remaining owners split the business ownership equally.

  • Wait-and-See Buy-Sell Plan: The business as a whole gets the first shot at buying out the departing owner. If it doesn’t do so as a business entity, then the remaining owners can buy the stake, individually or jointly.

  • One-Way Buy-Sell Plan: This involves a sole proprietorship in which the owner desires to sell out to a child, spouse, or chosen employee.

In addition to deciding on the type of buy-sell agreement, the partners in a business must also decide upon a valuation method. The three traditional valuation methods are:

  • Fixed-Price Agreement: A price is predetermined in the buy-sell agreement, though this price can quickly become outdated if the enterprise rises or falls in value.

  • Formula Agreement: The price is determined based on a preset formula, generally a multiple of the enterprise’s operations.

  • Business Valuation Agreement: The price is determined by outside appraisers.

Life insurance policies often play a big part in buy-sell agreements because the death of one partner can place the other partners in financial uncertainty.

Disputes When a Buy-Sell Agreement Doesn’t Exist

An ongoing partnership can be plunged into a life-or-death survival situation, especially if no buy-sell agreement is in place, when one or more of several events takes place, including:

  • One Owner Retires or Wants Out: If one of the owners suddenly decides to move on — whether to retire or pursue other interests — the remaining owners will have to come up with a way to buy out that person’s share or find a buyer for it.

  • One Owner Gets Divorced: California is a community property state, so a co-owner’s spouse will own that person’s share of the business equally and jointly. If a business is subject to the divorce of one owner, a buyout can become a messy affair, especially if the spouse puts up roadblocks as to price and financing.

  • One Owner Goes Bankrupt: Without a buy-sell agreement, if one owner files for personal bankruptcy, the entire operation may end up being liquidated to pay off his or her debts.

  • One Owner Dies: The business could end up in probate court and subject to a sale — at least of the decedent’s share — to meet creditor obligations.

Potential Buy-Sell Agreement Disputes

The sudden changes mentioned above can also threaten the survivability of a business even if a buy-sell agreement is in place. The other owner (or the business itself) may not have the financial means to buy out the departing owner’s share, or the remaining co-owners can dispute the valuation, however it is arrived at.

Do the remaining co-owners really want to seek a new partner if they can’t afford the buyout themselves, or even sell the entire operation to someone else? Given the need for quick decision-making, arguments can obviously ensue and interfere with the day-to-day running of the business.

Contact William B. Hanley, Attorney at Law for Help

Business disputes can threaten the very existence of an enterprise. When one owner suddenly departs, it can trigger bickering among the other owners even if they’ve already agreed on a buy-sell mechanism. The agreement itself may have become outdated or fail to provide the specifics necessary to head off disputes.

William B. Hanley, Attorney at Law, has been helping businesses resolve their disputes since 1974. Attorney William Hanley will review all documents and contracts relevant to the conflict, listen to the positions and claims of the co-owners, help mediate the dispute, and if necessary, develop a strategy to be pursued in court.

If you’re in Southern California, including the areas of Irvine, or throughout Orange County, Los Angeles County, or San Diego County, contact William B. Hanley, Attorney at Law, to help all parties involved work toward the optimal resolution of your dispute.