Mistake No. 5: Failure to Establish a Buy-Sell Agreement
All good things must come to an end. Successful businesses plan for this eventuality, and decide how to terminate their business relationships before one of the owners wants out.
Steve and Harold had operated their internet-based store for more than five years. Each of the men owned half of the stock in the company, with Steve handling the financial matters, while Harold focused on sales and marketing. They made a good team, and their business prospered.
Though they had similar goals when they started the business, Steve and Harold found that they no longer saw eye to eye. Harold wanted to expand the merchandise available at the store; Steve felt it was critical to focus on their existing product lines. When they could not reach a joint decision, Harold purchased new product lines over Steve's objections. Steve retaliated by ignoring the invoices from the vendor and shutting off Harold's cell phone.
Each of them wanted to separate their business relationship, but they did not know how. Harold said that he would sell his 50 percent of the business to Steve for $1 million cash. Steve hired an appraiser, who determined the value of the company to be $1.5 million, but Harold challenged the appraiser's opinion. Their disagreement became more and more contentious. Ultimately, they refused to talk to each other.
In desperation, Steve filed suit to dissolve the corporation. Sales stalled and the value of the company plummeted as the two owners wrestled with their legal dispute. Some eight months later, after they each spent more than $100,000 in attorneys' fees and litigation costs, Harold agreed to sell his interest in the company to Steve for $150,000. Each was bitter about the demise of the business; each felt that he had been cheated in their separation.
How to Avoid Mistake No. 5:
If you have business partners, you need a buy-sell agreement. Ideally, you should prepare the agreement when you set up the company. If you have not already formed a buy-sell agreement, do so immediately to ensure that you have a plan in place to address the transition of the business.
A buy-sell agreement typically addresses terms on which one owner can sell his interest to the other owners, setting forth the methods of calculating the purchase price and of establishing the terms of sale. Not only does it provide a mechanism for resolving impasses between owners, but it also provides an orderly way to handle the death, disability, illness, bankruptcy, divorce, or retirement of one of the owners. Among other things, a buy-sell agreement considers the following matters:
- When can an owner sell his interest in the business?
- Who is allowed to buy an interest in the business?
- Under what circumstances may an owner be required to sell her interest in the business?
- How will the parties determine the value of the interest in the business?
A properly drafted buy-sell agreement allows the ownership and management of the business to continue without having the departing owner's successor forced on the remaining owners. It also fairly compensates the departing owner for his interest in the company, while still meeting the liquidity needs of the company. Once the agreement is in place, you should review and update it regularly to ensure that it continues to meet your needs.