Owners of a business with more than one owner usually look for these answers after something has already happened. The answers below concern the owner agreement and its buy-sell provisions: the terms under which each owner offers that owner’s interest to the business or to the other owners when certain events, called triggers, occur.
Rick Riebesell is a lawyer and business consultant who has spent over thirty years advising owners of closely held businesses on succession, buy-sell agreements, and business transactions. He is the author of Implementing the Buy-Sell Agreement and publishes his writing on Owning a Business on Substack.
Do we have to buy the interest of a withdrawing owner?
Only if there is an agreement with that owner requiring that purchase. Most initial organizational documents do not prohibit transferring an interest outside the business’s current ownership. If there is a market for the departing owner’s interest, the buyer may not be an owner you would choose. You may want to be sure the interest cannot be sold to those outside the current ownership of the business (for instance, competitors or hostile parties). In a closely held business, buyers of the withdrawing owner’s interest outside certain groups, such as family, professional associates, or those focused on the same business goals, may not be welcome.
A provision providing for a transfer restriction is commonly in an owner agreement with buy-sell provisions, so the agreement cannot be avoided by selling to someone not bound by it. A complete restriction may not be enforceable under state law; however, a well-drafted agreement provides a withdrawing owner with defined terms of sale.
If an owner is also employed by the business, there will be issues under the employment law of the state. There will be a difference in desired treatment among the circumstances under which the employment is terminated. Voluntary departure will be viewed differently than a discharge for cause or a withdrawal to become employed by a competing business. A withdrawal because of disability requires special consideration. A well-drafted owner agreement will provide for state law compliance and different terms for the purchase of the owner’s interest in each circumstance.
Where there is no agreement, the answer depends on state law and the entity’s documents, and it is rarely the answer any of the owners would have chosen.
What happens to the business when an owner dies?
Death is the trigger owners think about most, and it is the easiest to define. The usual provision is a mandatory purchase as soon as possible, because the deceased owner’s family needs liquidity for an interest it is not suited to hold and cannot manage. Payment at death is often funded by life insurance and paid promptly, not negotiated or deferred, but there are significant tax consequences that should be considered.
Without an owner agreement and funding, the surviving owners may find themselves in business with the deceased owner’s family, which holds an interest it cannot manage. Neither side would choose that arrangement.
How is the purchase of a withdrawing owner’s interest funded?
When the departure is an event, such as retirement, which can be anticipated, the purchase amount and terms can be negotiated before the event. Where the withdrawal occurs without notice and purchase of the interest is desired, the funding for such a purchase can be a significant issue. In either case, the planning for funding the purchase of the interest should be in place and documented in the owner agreement.
A stress test makes the problem concrete. State the event: “John dies tonight.” List everything that affects the business as a result. Then work through, step by step and in detail, how each of those things would or would not get done, including funding the buyout for John, and document what you find.
The owners are deadlocked. What can we do?
Deadlock is a sustained disagreement among the owners over a fundamental issue affecting the business, usually between owners or owner groups holding equal voting power, or between a majority and a minority holding a veto over a specific decision. Once deadlock is declared, to avoid a prolonged conflict, the owner agreement must provide the answer to a hard question: who buys and who sells?
In the simplest version, one owner sets a price per share, and the other owner must, within a stated period, either sell at that price or buy at that price. In a variation, the other owner may instead name a higher price at which the first owner must sell or buy. Other agreements use a special class of stock held by a neutral third party to break the deadlock, or, where the business can be divided, separate it between the deadlocked owners rather than requiring either to buy the other out.
A co-owner is getting divorced. Can the spouse become an owner?
General transfer restrictions may not reach a transfer made as part of a divorce, because courts often treat that transfer as involuntary. The remaining owners rarely want a divorced spouse to become an owner.
The agreement should address divorce specifically: the owner has the first right to acquire any interest awarded to the former spouse, and if the owner does not, the business and then the remaining owners have the right to acquire it.
Owners should also know that the price stated in the buy-sell provisions will not necessarily be treated as the value of the interest in the divorce proceeding. The two valuations serve different purposes and are not automatically the same number.
We cannot agree on what an ownership interest is worth. How is value settled?
There is no single number. A transfer between owners is often valued at “fair value”; a sale to an outside buyer is valued at “fair market value.” The two standards do not automatically produce the same result, and an agreement that uses the word “value” without defining it invites a court to fill the gap. A formula is tempting but unreliable over time, and book value is rarely an appropriate transaction price.
The more dependable path:
- Have discussions about value among the owners.
- Bring one appraiser into the discussion.
- Have the appraiser set a stated price for each type of transaction the agreement covers.
- Repeat the process every year for at least three years, then on a regular schedule after that.
Repeating the process gives the price its integrity. The agreement is only as good as the owners’ willingness to follow it, and if a provision is not perceived as fair, the owner it affects will not comply.
We do not have an owner agreement. Where do we start?
Not with a lawyer and a form. A lawyer asked to draft a buy-sell agreement without a plan will either hand you a form document that does more harm than good or, if the lawyer is a good one, ask for your written succession plan first.
Start with the owners. Have difficult conversations, one issue at a time: restrictions on transfer, the business entity, governance, triggers, the procedure after a trigger, funding, and value. Document each conversation. The accumulated documentation becomes the succession plan, and the agreement is drafted from the plan. If you cannot follow this process, find a consultant to facilitate. Bring in an appraiser and an attorney as needed. Do not procrastinate by taking longer than six months to formulate the plan.
The Owner Agreement Project
Business Transition Consulting works with all of the owners together to turn these conversations into a written succession plan and an owner agreement drafted from it. Learn about the Owner Agreement Project
This page provides general information, not legal or tax advice. Business Transition Consulting LLC is a consulting firm and does not practice law.