Some Problems With Buy-Sell Agreements

By Cliff Ennico

April 16, 2019 6 min read

I recently had the privilege of examining a volume of legal forms whose publisher wanted me to take over as general editor.

I was generally OK with the corporation and LLC forms — that is until I got to the chapter titled "buy-sell agreements." These agreements deal with the common situation in which an owner of a small business either wants to leave the company or needs to be forced out. In such situations, it is customary for the company, or the departing owner's business partners, to purchase the departing owner's interest in the company for the price specified in the agreement. That way the departing owner can get on with his life, and the company can get on with its business. Simple enough, right?

I have to say I was utterly appalled by the forms that appeared in this volume — forms that lawyers throughout the country have been relying on for years — because none of them worked the way they should.

Generally, a buy-sell agreement has three parts:

—A list of events that will trigger a buyout of a departing owner's interest.

—A requirement that the company or the remaining owners purchase the departing owner's interest.

—The purchase price the departing owner will receive.

List of Events. Many of the buy-sell agreement forms did not clearly specify the circumstances that would trigger a buyout. Some called for a buyout if the departing owner's "employment with the company terminates." There's just one problem: Business owners are not considered employees, even though they work in the business every day, and a departing owner who doesn't want to sell out could use that to wiggle out of the agreement.

Other forms called for a buyout upon an owner's voluntary withdrawal. That's great if the owner states specifically in writing that he is withdrawing from the company. In reality, though, that seldom happens. What happens is that the business owners have a falling out and stop talking to each other. At what point can an owner who just refuses to show up for work be considered to have voluntarily withdrawn from the company? These forms offer no guidance.

Requirement of a Buyout. Many of the forms stated that upon a triggering event, the departing owner "may" sell, and the company or remaining owners "may" purchase the owner's interest. Without making this a hard-and-fast requirement, there's no assurance that anything will happen.

The whole purpose of a buy-sell agreement is to prevent a departing owner from remaining on board as a passive investor, draining the cash and resources without contributing anything of value. A buy-sell agreement that does not obligate the departing owner to sell and the company to buy the owner's interest completely defeats that purpose.

Purchase Price. Here's my biggest beef with these agreements: Very few of them stated specifically what the purchase price will be. Yes, I understand that it's extremely difficult to put a value on a privately owned business, especially one that's just getting off the ground and doesn't have revenue or profits yet.

But refusing to specify a purchase price defeats the whole purpose of a buy-sell agreement, which is to get the departing owner out of the business as quickly and efficiently as possible.

Some of the agreements required the company accountant to value the departing owner's interest. Sounds fair, but there's a problem: The company accountant is not required to sign the agreement. What if she refuses to do so (heck, I wouldn't get involved if it were me)? The agreements don't say.

Many of the agreements contained what we lawyers cynically call a "Three Stooges" appraisal clause to value a departing owner's interest. Here's how it's supposed to work: The company appoints an appraiser; the departing owner (or his estate, if he's deceased) picks another; and if the two appraisers disagree, they appoint a third appraiser who mediates the dispute and sets the price.

Sounds really fair, right? There's only one problem. It never happens. It takes bloody forever for each side to appoint an appraiser. Then, inevitably, the appraisers can't agree on a date to get together. Tax season intervenes (the appraisers are usually accountants or CPAs), and nobody hears from either of them for months.

Then they finally do get together, and their valuations are wide apart. Because they now don't like each other, they refuse to communicate and appoint the third appraiser, as the agreement requires. Months drag on; the departing owner remains a drag on the business; and nothing gets done.

If you have partners in your business and you have a buy-sell agreement in place, there's a good chance it isn't any good, especially if your lawyer relied on one of the agreement forms in the volume I reviewed.

Take your buy-sell agreement to your lawyer, and ask her some tough questions about what precisely will happen — when and how — if you or one of your partners decides to leave the business. If she has trouble answering, it means your agreement has holes in it and should be renegotiated.

The right way next time ...

Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.

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