Business Survival and the Buy-Sell Agreement

Posted August 22, 2014

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HOW DOES A BUSINESS SURVIVE the death, disability or retirement of one of its key manager-owners?  This vexing problem can be tackled with the help of a BUY-SELL AGREEMENT drafted by a skilled business lawyer.  Most businesses have more than one owner who is a key manager.  This is so regardless of the legal form of the business.   A limited liability company (“LLC“) will typically have at least two LLC members who run the business.   A subchapter “S” corporation usually has two or more manager-stockholders.   A limited liability partnership’s (“LLP’s“) will rely upon the management expertise of general partners owning majority stakes in the business.  Without adequate planning, the departure of one of the key owner-managers will have a devastating impact upon the survivability of the business, not to mention the remaining owners.  And what of the deceased owner’s spouse and children?  What happens to them?

FOR EXAMPLE, suppose four dentists run an active practice, organized as a professional medical corporation.  Each owns 25% of the corporation’s outstanding stock.  One of the dentist dies suddenly.  How is the dental practice going to maintain its revenue stream?  How will the surviving dentists pay the dental corporation’s office lease, equipment loan, and computer systems servicing contract? Where are they going to get enough funds to quickly hire another dentist, and keep patients from going elsewhere?  And what about the deceased dentist’s spouse?  How is she or he going to survive the loss of income?

The key is to have an adequately funded BUY-SELL AGREEMENT in place.  A buy-sell agreement is an agreement between two or more owners of a business that says what happens if one of them dies, becomes disabled, decides to leave, or is forced to leave.  Typically it involves a buyout of the deceased or departing owner’s equity interest by the business entity itself.

Adequately funding the BUY-SELL AGREEMENT a key sticking point.  Most businesses cannot afford to set aside a buy-out reserve.  The usual practice is for the business to purchase one or more life insurance policies on its key owner-managers to deal with the death or disability situation. In the case of retirement, the buy-sell will be deferred using an installment note, funded by future cash flows once the business gets back on its feet.

A skilled business attorney will draft the BUY-SELL AGREEMENT to take into account the needs of the owners.  Carefully defining the triggering events, establishing the buyout price, and methods of funding the agreement should be spelled out in detail in the agreement.   The BUY-SELL AGREEMENT also will have present credit advantages.  Many lenders will not extend credit to closely-held businesses that do not have a continuity plan in place.  Those who do may insist on having a call provision in the note, meaning that if one of the key 0wner-managers dies, the loan becomes immediately due and payable in full.  This is yet another reason to seek the advice of a business attorney to ensure that your business is protected from the loss of one of its owners.

BURLINGAME, CALIFORNIA.  By Christopher Shenfield, Esq.  If you have any questions about this article, feel free to contact us at chris@shenfieldlaw.com or 650.373.2054.