Love-silly engaged couples don’t often plan for divorces, but grim statistics show that they do indeed happen. The same is the case for would-be business partners. So if you’re thinking about going into business with others, a buy-sell agreement is a must.
Known as a business pre-nup, the document spells out when and how you and your partners can leave the business — and what will happen if one of you dies. Of course, no one wants to think about how they'll get out of a business they've just stepped into, but it's critical nonetheless. Aside from life and disability insurance to account for a death or serious injury, there are many other elements to consider.
Here, experts examine seven often-overlooked and very important scenarios you should consider when drafting a buy-sell.
No. 1) The Personal Guarantee
If you signed a personal guarantee on a business loan, you're personally liable if your business defaults on the debt. And when you decide to leave the business, you may still be on the hook for that company loan, if you don't include a provision in your buy-sell.
"Get agreement up front that if you're out of the company, those partners who choose to stay in will take on the debt, make reasonable efforts to have you removed from the guarantee and hold you harmless," said Loren Andrulis, an attorney with law firm Warner Norcross & Judd in Grand Rapids, Mich.
Of course, this is only as good as your company's credit-and-financial health, which you can't project when the business is in its infancy. But Andrulis encourages partners to include the provision anyway.
No. 2) The Intellectual Property
If your business has intellectual property, such as a patent, you'll want to decide in advance what it's worth and who will get it if a partner wants out.
"If you've got a patent process or trade secrets, you want to make sure you put in a provision that protects everybody," said Lori M. Lofstrom, managing shareholder of Holmes Lofstrom, a Long Beach, Calif.-based law firm that works with startups on buy-sell agreements. "People can get ruthless in competitive industries."
"Address at the outset where [the intellectual property] goes," added Andrulis. "Perhaps the person who created it is the person who takes it back."
No. 3) The Spouses
If any of the partners are married, you want to consider that in your buy-sell, especially in states where there are community property laws that apply in a divorce. Someone else’s ex-spouse can end up getting half of everything, including the business you worked so hard to build.
"It can get very messy," warned Lofstrom, noting that a spousal consent form can remedy the problem. "If they haven't signed the form to abide by the specifications of the buy-sell, now you're forced to do business with someone's spouse."
No. 4) The Multiple Buyout
Buying life insurance, in the event a partner dies, is the most common stipulation in a buy-sell. But few business owners plan for the unlikely (yet very possible) scenario where more than one partner retires or simply wants out—at the same time. Get ready for an overwhelming drain on the company's cash if you didn't provide for this scenario in your buy-sell.
"I often see clients in a crippled situation because more than one owner leaves at once," Andrulis said. "Put a limit to the total amount of buy-out payments within a particular year, that's tied to a percentage of revenues, for example."
No. 5) The Deadlock
If you have an equal partner, but end up with very different ideas on how to run the business, you can end up in a deadlock. So, decide in advance how you'll handle that in your buy-sell — or risk having to liquidate your business.
"You can decide to submit the question [that put you in a deadlock] to an arbitrator for a resolution," Andrulis said. "If the company is crippled, you can give one person the option to buy out the other. Maybe one [partner] puts a price on the table, and the other can say ‘I'll sell for that’ or ‘I'll buy for that.’"
No. 6) The Forgotten Assets
"It's not uncommon for business owners to own the real estate [a business sits on] as a separate entity," Andrulis said. "But you want to make sure they're tied together in terms of the buy-sell."In other words, if you decide you want out of the business, remember to consider everything that you own—including what is listed as a separate entity. These outside assets are often overlooked in the initial buy-sell agreement, so be sure you cover all your bases.
No. 7) The Lawyers: They’re Not one-Size-Fits-all
When you're bootstrapping a business, you may only think to hire one attorney for all partners in an effort to pinch pennies. Think again.
"Don't assume the lawyer is your lawyer," Andrulis said.
Unless you're the one bringing the attorney on board, your interests may not be equally represented in the buy-sell or any other document that affects you in the business. Andrulis suggests hiring your own attorney. Yes, it may cost you more upfront, but it could save you much more when it's time to exit the business.
And remember, a buy-sell agreement is not a one-time consideration. Pull it out every few years to make sure it still makes sense. Always consider tweaking it whenever there are major changes in the business (such as acquisitions or layoffs) and the partners' lifestyles (like when someone gets married or starts a family).
Preparing yourself for as many scenarios as possible—no matter how painstakingly uncomfortable it may be—will give you and your partners the peace of mind you'll all need to sustain the success of your small business.