In this article, we explain buy-sell agreements for closely-held corporations, LLCs and Partnerships in Illinois. We answer the questions, "what is a buy-sell agreement?", "when should business owners form a buy-sell agreement?", and "what types of events do buy-sell agreements cover?" We also discuss buy-sell agreements for the death or disability of a business owner, buy-sell agreements for limitations on the sale of an owner's stock, buy-sell agreements for involuntary termination of an owner's ownership interest, and using buy-sell agreements to plan for an owner's retirement.
What is a buy-sell agreement?
A buy-sell agreement is a contract between the owners of a business that sets forth certain triggering events that will allow the owners to exit from the business, who will be permitted or required to buy their shares, how the shares will be valued for purchase, and how any such purchase will be funded.
Business owners will generally work with an attorney to navigate each of these issues in light of their specific circumstances. One-size-fits-all buy-sell agreements are inadvisable, because the facts surrounding each business and the needs of its owners are different in every situation.
Buy-sell agreements may be included in the governing documents of the corporation, LLC or partnership or may be executed as a separate agreement between the shareholders.
When should business owners form a buy-sell agreement?
Whenever a business has a relatively small group of owners (as opposed to a public corporation), the business should have a buy-sell agreement in place in order to minimize the financial risk of each owner should one of the triggering events occur. This agreement should ideally be created when the business is initially organized or as soon as practicable thereafter in order to ensure that all of the owners are negotiating from the same position. The longer the business is in operation, the greater the likelihood that the interests of the business owners will diverge. If this happens the agreement will be more difficult to negotiate.
What types of events do buy-sell agreements cover?
Buy-sell agreements may cover some or all of the following events:
- The death of an owner;
- The disability of an owner;
- Voluntary termination of an owner’s ownership;
- Involuntary termination of an owner’s ownership with or without cause;
- Termination of an owner’s interest in the company if the owner files for bankruptcy;
- Termination of an owner’s interest in the company if the owner files for divorce;
- Termination of an owner’s employment with the company; and
- Retirement of an owner.
Buy-sell agreements for death or disability of a business owner
If one of the owners of a business dies or becomes disabled, the other owners may not want to be in business with the deceased or disabled owner’s spouse or heirs. On the flip side, the deceased or disabled owner’s spouse or heirs may not be interested in participating in business ownership, and may instead prefer a payout in return for their ownership interests.
A buy-sell agreement may provide that when an owner passes away or becomes disabled, the company or the other owners individually will be required to purchase the owner’s stock from the owner’s estate. The agreement will generally provide for a method for valuing stock for the sale.
If the company’s purchase of an owner’s stock is mandatory upon death or disability, the agreement should provide for how the company will be funded. If the company or shareholders do not have liquid capital available for the stock purchase at the time of an owner’s death or disability, this can put all parties in a bad position. A common solution to this problem is for the company to purchase life insurance policies on the lives of each of the owners in order to fund the stock purchase contemplated by the buy-sell agreement.
Buy-sell agreements for limitations on the sale of an owner’s stock
Generally, owners of a closely-held corporation, LLC or partnership will want to have control over who they will be partnering with in the future. For this reason, it is common to include in a buy-sell agreement limitations on the sale of an owner’s interests in the company. The agreement will often give the company or the other owners right of first refusal when an owner wants to sell his or her ownership interest. The agreement may make purchase by the company mandatory in certain situations. The agreement should provide for how the ownership interest will be valued and whether the payment will be made in a lump sum or over time.
Buy-sell agreements for involuntary termination of an owner’s interest in the business
There are many situations in which the owners may seek to terminate an owner’s interest in the company against the owner’s will. This may be with or without good cause. The buy-sell agreement should provide for a list of events that qualify as good cause for termination of an ownership interest, such as embezzlement or competition with the company.
The agreement should spell out a procedure for the purchase of the owner’s stock in the event of an involuntary termination. It may provide different methods for setting the purchase price depending on whether the termination is with or without cause.
The agreement may also provide that an owner may be forced to sell his or her shares in the event of divorce or bankruptcy in order to prevent a situation in which the spouse or the bankruptcy trustee becomes an unwanted business partner.
Using buy-sell agreements to plan for an owner’s retirement
At some point, the owners of a business will likely want to liquidate their business interests in order to fund their retirement. This is likely to occur at different times for each owner. A good buy-sell agreement will provide a process for triggering a buy-out of the retiring owner by his or her partners. This may be financed by a bank loan or by the seller via a promissory note and a long-term payment schedule. The agreement should also provide for how much notice will be required in order to trigger the buy-out requirement.
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