When starting a new business, the last thing that owners worry about is what happens with their business ownership if one of them becomes disabled, gets divorced, dies or simply decides to get out of the business to start another one or to retire. There is just not enough time to think about all that when you are working around the clock trying to lift your business off the ground. “Let’s deal with this when/if it comes to that” is the common attitude.
Actually, the worst mistake that co-founders can make is to ignore these questions before they arise. After all, if you are the co-owner who wants to get out, you need to ensure that you get bought out by the remaining partners at a fair price (you want to be compensated for all that hard work and time spent building the business). On the other hand, if you are the owner who is staying, the departure of a partner may leave the business vulnerable and you are not sure if you would like working with the new partners. To avoid these tensions, co-owners should think through these questions at the very beginning of their business venture, well before any of these problems come up (you just never know when and how soon this may happen).
So, what can really happen if you don’t have buyout provisions in your partnership agreement? If you want to leave, you may find yourself arguing endlessly and bitterly with your co-owners as to what the fair buyout price should be. If you die, your survivors may be stuck with a share in a business that no one wants to buy or for which the co-owners would not pay a good price. If a co-owner files for personal bankruptcy or has defaulted on a personal secured loan, you may end up sharing the business with a bankruptcy trustee or a creditor. Finally, if a third party buys an interest from the co-owner or a family member of a deceased partner inherits the interest, you may have to work with new co-owners who are inexperienced in running the business or who have different views on how this should be done.
Buyout provisions (also called buy-sell provisions or agreements) cover when and how the owners of a business can sell his or her interest, at what price, and who can or must buy their interest. A buyout agreement may provide for forced buyouts that give owners the right to force the company to purchase their interests in certain circumstances (retirement, death, disability). Also, buyout agreement may prevent the sale of interests to the third parties and provide for a way for co-owners to buyout the owner who wants to get out. Further, buyout agreement can set forth what happens if a co-owner stops fulfilling his or her responsibilities at the company and becomes an inactive partner. Buyout price should be agreed to ahead of time and will depend on whether the co-owners choose a valuation option or a fixed price formula that is right for the business. Finally, buyout agreements address how the buyout price will be paid out (installments or outright) and how it will be funded (common methods include purchasing disability and/or life insurance).
Hopefully, by now, you are already persuaded to insert buyout provisions in your partnership agreement, which are essential to the long lasting success of the business.
This article is not a legal advice, and was written for general informational purposes only. If you have questions or comments about the article or are interested in learning more about this topic, feel free to contact its author, Arina Shulga. Ms. Shulga is the founder of Shulga Law Firm, P.C., a New York-based boutique law firm specializing in advising individual and corporate clients on aspects of business, corporate, securities, and intellectual property law.