Assume there’s a business called ACME, Inc., and it’s owned and controlled by two shareholders, Mr. Alpha and Ms. Bravo. (This hypothetical also applies to an LLC and its owners, which are called “members.”) Each of Alpha and Bravo have families, and their respective families don’t really involve themselves in the business. Alpha and Bravo have a good relationship and know each other’s families on a social level. That said, they’re both happy to have each other as business partners and wouldn’t want to be in business with anyone from the other’s family.
So what happens to the business if, say, Alpha passes away or is involved in an accident that permanently incapacitates him? Well, if steps weren’t taken prior to that event to dictate what happens, Alpha’s family will end up owning 50% of the company. That means the family will now have the right to start making ACME’s business decisions and involving themselves with the company’s strategy, none of which Bravo wants to happen. How could Bravo have protected herself from being forced into a business partnership with people she hardly knows, and who don’t have the business experience, acumen and savvy that Alpha had? (I’ve seen this happen – an 80-year old shareholder died and his widow took ownership of his shares. Problem: The surviving shareholders never even knew their deceased partner was married in the first place. The guy had secretly gotten married to someone much, much younger about a year before he passed, and that surprise widow was now their surprise business partner.)
What Bravo could have done was enter into what’s known as a Buy-Sell Agreement (sometimes referred to as a “Buy-Sell”) with Alpha, which is kind of like an agreement for a future buyout of one owner by the other, and which cashes out the family and leaves ownership and control vested solely in the surviving shareholder. Paraphrased, a Buy-Sell agreement says, “In the event one of us passes away or is incapacitated (or does something really bad that negatively affects the business), then the company has a right of first refusal to buy that owner’s shares. If the company doesn’t have the money to buy the shares, then the surviving shareholder has the right to buy them. If the surviving shareholder doesn’t want to buy the shares, then the shares go to the family.” Obviously, there’s a lot more to it such as valuation of the shares, financing the purchase price, notice periods, etc., but the foregoing paragraph is how the plan generally works.
So, if you’re one of the owners of a business with multiple shareholders, and you’d like to protect yourself and the company against a situation in which near-strangers are plopped into your lap as your new partners, you need a Buy-Sell Agreement. It’s good for you, it’s good for the business, and, ultimately, it’s good for your relationships with your partners.
Greg Borman is an attorney in San Diego whose practice encompasses helping businesses and their owners with their legal needs. He can be reached at (858) 232-7100 at email@example.com