Business partnerships rarely end the way they began. A partner may want to retire, get divorced, become disabled, pass away, or simply want to move on to something else. A buy-sell agreement — sometimes built into an LLC operating agreement or drafted as a standalone document — is what determines what happens next, rather than leaving it to negotiation under stressful circumstances.
What Triggers a Buy-Sell Provision?
A well-drafted buy-sell agreement anticipates multiple triggering events, each of which may call for different handling:
- Voluntary departure — a partner simply wants to sell their interest and leave
- Death — often funded through life insurance held on each owner
- Disability — a partner becomes unable to actively participate in the business
- Divorce — preventing a partner’s ex-spouse from becoming an unintended co-owner through a divorce settlement
- Bankruptcy — preventing a partner’s creditors from gaining an ownership interest
- Termination for cause — a partner engages in misconduct or breaches the agreement
Valuation: The Provision Most Likely to Cause Disputes
Perhaps the single most important — and most commonly under-negotiated — element of a buy-sell agreement is how the business (or the departing owner’s share) will be valued. Common approaches include:
- Fixed price, agreed upon and updated periodically — simple, but requires discipline to actually keep current
- Formula-based valuation — a defined multiple of revenue or earnings, applied automatically
- Independent appraisal — a professional valuation obtained at the time of the triggering event, often the fairest but also the most expensive and time-consuming option
Without a clear valuation mechanism agreed upon in advance, remaining and departing owners are left to negotiate value under exactly the circumstances least conducive to agreement — often after a death, disability, or falling-out.
Funding the Buyout
Even with a clear valuation method, the remaining owners need a way to actually pay for the departing owner’s interest. Common funding mechanisms include:
- Life insurance — commonly used to fund a buyout triggered by death, ensuring cash is available without straining the business
- Installment payments — spreading the buyout amount over time, with terms (interest rate, payment schedule, security) defined in advance
- Sinking fund — the business sets aside reserves over time specifically for future buyouts
Right of First Refusal
Many buy-sell agreements include a right of first refusal, requiring a member who wants to sell to a third party to first offer the interest to the other owners (or the business itself) on the same terms. This prevents an unwanted third party from becoming a co-owner without the other members having a say.
Why This Matters Even Between Friends and Family
Business partnerships between friends, family members, or long-time colleagues are sometimes the ones most likely to skip formal buy-sell planning, under the assumption that “we’ll work it out” if something happens. In practice, these relationships often have the most to lose from an undefined exit process, since personal relationships and business interests become tangled together during a dispute.
Setting up a business partnership, or realizing your existing business doesn’t have a buy-sell agreement in place? Brent A. Levison, P.A. helps business partners plan for ownership transitions before they become disputes. Contact the firm today for a consultation.
The information in this article is provided for general informational purposes only and does not constitute legal advice. For advice specific to your situation, please consult a qualified attorney.