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The Importance of Buy-Sell Agreements

Three business owners thought they were doing the right thing when they created their LLC. However, mistakes they made at the time and a decision made after the death of one of the three have harmed the business and everyone involved. You can learn from their mistakes.

What happens upon the death, divorce, disability or bankruptcy of a business owner? What happens when there are disputes between owners? What happens to the business? How are the owners protected?

These questions can be answered by co-owners in advance in a buy-sell agreement. Whether related by birth, marriage or business association, a little time up front can prevent problems down the road.

A buy-sell agreement is like an insurance policy. If all goes well, you will not need it. Similarly, if you need it but do not have it or it is inadequate, there can be devastating consequences.

Our three partners formed a limited liability company (LLC). Like most LLC operating agreements, there were a couple of paragraphs dealing with the death of an owner. When one of the three died, the other two wanted to help their friend’s widow and allowed her to continue as an owner of the LLC. Once that decision was made, they no longer had an option to purchase her interest.

Their new “partner” did not have the business judgment of her deceased husband. Without her guarantee, they cannot get bank financing. This is just one of the many ways in which the operation of the business has been harmed. The original partners would like to buy her out but she is demanding far more than the business is worth. Friendships have been damaged, the business is suffering and value has been lost.

The three partners could have agreed to a comprehensive buy-sell agreement at the time they formed their business. It could have covered not only what would happen upon the death of a partner but would have continued if the surviving partners allowed a widow to take a deceased partner’s place. The widow’s interest, like her husband’s interest, would then be subject to that agreement. If there was then a dispute, there would be a mechanism for resolving the dispute and, if necessary, a means for valuing each of the parties’ ownership interests. 

Another possibility, upon the death of the third partner, the two original members and the widow could have entered into a buy-sell agreement. This might have been difficult to do but would certainly provide the answer to today’s problems.

Usually, each party to a dispute will state that all they want is what is "fair." Perception, however, depends upon perspective. Perceptions of fairness are influenced by each party’s circumstances. A buy-sell agreement, drafted at a time when each of the owners share a common vision, can guide you to a fair resolution.

Do not rely on the simple buy-sell provisions contained in an LLC operating agreement. If you are in business with partners or are starting a business, take the time to think through a buy-sell agreement. Consider it insurance. Then, if an unexpected life event takes place or conflict develops between owners, you will have a means to protect the business and protect the interests of each of the parties involved.

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