Buy-Sell Agreements In Iowa Explained

In this article, our Iowa business attorneys discuss buy-sell agreements in Iowa and answer the following questions:

• What is a buy-sell agreement?
• When is a buy-sell agreement appropriate for a business?
• What events does a buy-sell agreement cover?
• How does a buy-sell agreement help in the death or disability of a business owner?
• Can a buy-sell agreement limit the sale of an owner’s stock?
• Can a buy-sell agreement protect the company during involuntary termination of an owner’s interest in the business?

What is a Buy-Sell Agreement?

Starting and building a business is hard enough when all the owners are healthy and working together. But what happens when one of those owners suddenly becomes ill, dies, or runs into some other financial or legal trouble? The operating agreement may have a few stipulations for these scenarios, but it mostly focuses on how the business is to be run and the relationship between the various partners. You might think that you’ll just deal with any ownership problems as they come at the business, but why put the company at such risk? Without proper planning, the death of an owner can be enough to send even an established business into a tailspin. Enter the Buy-Sell agreement.

A buy-sell agreement is a “contract” between the partners of a business that addresses the concerns below:

• Under what circumstances the buy-sell agreement is triggered;
• When a business may legally dispose of an owner’s interest;
• How to handle the remaining owner’s ability to buy the interest of a leaving owner;
• The financials around buying the owner’s interest;
• Guidelines for any potential new owner and who the current owners will accept;

Business owners will typically employ an attorney to help them work through the various scenarios that a buy-sell agreement will cover. Since the needs of every company are different, a generalized buy-sell agreement is not suggested.

When is a Buy-Sell Agreement Appropriate For an Iowa Business?

Any business that will have more than one owner should strongly consider generating a buy-sell agreement at the time the company is being formed or shortly thereafter. Drafting the buy-sell agreement early on when all the owners are on the same page is the best way to avoid any initial conflict between the partners. As a business grows the interests of the different business owners will likely diverge making it much harder to create an effective Buy-Sell agreement. To find out how to fund a buy-sell agreement read our article, Raising Capital to Buy Out Another Owner.

What Events Does a Buy-Sell Agreement Cover?

Buy-sell agreements are usually constructed to cover some or all of the following scenarios:

• Death of an owner;
• Disability of an owner;
• Voluntary or involuntary termination of the owner’s ownership for whatever reason;
• Termination of an owner’s employment with the company; and
• Retirement of an owner

How Does a Buy-Sell Agreement Help In the Death or Disability of an Owner?

When the owner of a company dies or becomes permanently disabled it raises a lot of potential issues for the remaining owners. Perhaps the owners don't like the idea of working with the family members who would inherit the dead owner’s interest. Or maybe the family members would rather have a payout for their inherited share of the decedent’s interest. In either scenario, if no agreement exists describing what should happen upon the death or disability of an owner a costly legal proceeding will likely ensue.

It’s common for a buy-sell agreement to stipulate upon the death of an owner that the company or the remaining owners will be required to buy the decedent’s remaining stock in the company. The buy-sell agreement should also describe a method for valuing the stock and the process for purchasing the stock.

If when drafting the buy-sell agreement the owner’s decide to make purchase of a dead owner’s interest mandatory the company will need to make sure there is a way to fund the buy-sell agreement, should money not be available in the untimely death of an owner. One common way to do that is by purchasing a life insurance policy for each owner that will cover the cost of his or her interest in the company.

Can A Buy-Sell Agreement Limit the Sale of An Owner’s Stock In an Iowa Business?

Partner’s of an LLC, closely held company or partnership business will typically want to have some control over who they will be partnering with in the future. For this purpose, the buy-sell agreement will contain stipulations limiting the sale of an owner’s interest in the company. Giving the company or partners the right of first refusal when an owner wants to sell his or her shares is a common guideline listed in a buy-sell agreement. The owner may decide to make it mandatory that the company have the right to first buy the leaving owner’s shares before they are available for purchase by a third party. The agreement should also describe how the shares will be valued and how they must be purchased, whether over time, one lump sum, etc.

One of the most common stipulations in a buy-sell agreement concerns how to handle the retirement of an owner. A good buy-sell agreement will describe a process of triggering the buy-out of a retiring owner by his or her partners. The buy-sell agreement should describe how the retiring owner’s interest could be purchased and how much notice is required to trigger the buy-out requirement.

Can a Buy-Sell Agreement Protect the Company During Involuntary Termination of an Owner’s Interest in the Business?

It’s not uncommon in the lifetime of a company for the owners to seek the termination of one or more owner’s interest in the company against the owner’s will. These decisions should be made with the company’s best interests in mind, but forced termination of an owner’s interest may be with or without good cause. The buy-sell agreement should contain a list of reasons why an owner’s interest can be terminated, such as embezzlement or undue competition to the company. The agreement should also contain guidelines for buying the interest of an owner going through divorce or bankruptcy.