If you are starting a new business with one or more partners – or if you are in an existing partnership business and have not thought about these issues in a while – it is important to make sure your company’s governance documents include good, detailed, well-drafted “buy-sell” provisions to help the partners navigate the possible future scenarios in which one partner might wish to leave, or might be required to leave, or might have already left, the company.

Buy-sell provisions can be set forth in a standalone agreement, or they can be included within your operating agreement (for LLCs), shareholder’s agreement (for corporations), or partnership agreement (for partnerships).  Properly drafted buy-sell provisions will accomplish several important objectives:

1. ‍Orderly Procedures for Ownership Transition: The buy-sell provisions will establish a clear mechanism for handling the transfer of ownership for each of the many foreseeable situations in which one partner could leave the business, including:<ul><li>The partner wishes to sell their partnership interest and withdraw (this scenario is commonly handled by giving the company and/or the other partners the exclusive first right(s) to buy the departing partner’s interest, before such interest can be offered or sold to a third party)</li><li>Death of the partner</li><li>Long-term disability of the partner</li><li>Retirement of the partner</li><li>Divorce of the partner that might cause the partner’s spouse to acquire all or part of the partner’s interest in the company</li><li>Bankruptcy of the partner</li><li>Sudden resignation of the partner</li><li>Separation of the partner for “cause” (i.e., where the other partners elect to expel the partner by reason of such partner’s serious misconduct or gross negligence that is likely to be injurious to the company’s business, reputation, goodwill, employee relations, legal standing, etc.)</li></ul>
2. Fair Valuation: Good buy-sell provisions will establish a clear method for determining the fair market value of the business and the departing partner’s share. There may be different valuation formulas based on the circumstances of the partner’s departure: for example, if a partner is expelled from the company for “cause”, or if a partner suddenly quits the business, leaving the other partner(s) in the lurch, the agreement may include a mechanism for reducing the price to be paid for the departing partner’s share. Having clear provisions that lay out all of the rules in advance will help prevent either side from overvaluing or undervaluing the departing partner’s interest and will be fair to both parties.</br>‍
3. Continuity of Operations: Well-crafted buy-sell provisions can help ensure that the business can continue to operate without significant disruption following the departure of a partner. This is crucial for maintaining the long-term stability and success of the business. For example, if the company is redeeming (buying back) the departing partner’s shares, a preferred drafting approach is to give the company the option to pay the redemption price at closing in the form of a partial cash payment with a promissory note for the balance, which allows the company to spread out the remaining payments over an agreed-upon time period at an agreed-upon interest rate.</br></br>
4. ‍Conflict Resolution: The buy-sell agreement should help prevent disputes from arising when partners disagree about the value of the business, the terms of the sale, or who can buy the departing partner’s share, and provide a clear path to resolution. One common drafting approach when a business is owned by two partners is to include a “standoff” or “shootout” provision, in case a future scenario arises in which the partners are no longer getting along –professionally, personally, or both – as well as they once did, and they decide that one of them needs to go.  Under this type of provision, either partner may initiate the buyout process by making an offer either to buy the other partner’s interest or to sell their own interest to the other partner, at a price named by the offeror.  The other partner then has the option either to accept the offer as presented, or to reverse the offer back onto the offeror, on the exact same terms.  In other words ,if Partner A offers to buy Partner B’s share for $100, Partner B can either accept the offer as presented or buy out Partner A’s shares for $100 instead. (And likewise, if Partner A’s initial offer is to sell Partner A’s shares to Partner B for a stated price, Partner B has the right to accept those terms or to require Partner A to buy Partner B’s shares for that price instead). The concept is the same as when parents tell two children who want to split a piece of cake that one child gets to cut it into two pieces and then the other child gets the first choice of which piece they want. There is a built-in honor system that assures that the partner making the initial purchase or sale offer to the other partner will endeavor to value the interest as fairly as possible, lest they be hoisted on their own petard and forced to accept the less desirable side of the bargain that they themselves fashioned.</br>‍
5. Financial Security: Another benefit of a good buy-sell provision is, in the event of a partner's death or disability, ensuring that the partner’s family or heirs will receive a fair financial compensation for the partner’s share in the business. This can provide financial security for the deceased or disabled partner’s family while also (as aforesaid) helping avoid the disruption of the business.</br></br>
6. ‍Preventing Undesirable Transfers: Buy-sell provisions will customarily include restrictions on who can buy, inherit, or otherwise acquire a departing partner’s share, which is a particularly important concern if the company operates a going business that requires each partner to be actively involved in day-to-day operations and in major business actions and decisions. The remaining partners who are carrying on the business will want to prevent, for example, the introduction of an unwanted new business partner that they do not know and did not select, or the possible sale of a partner’s share to a competitor, or having a partner’s shares become part of an estate in bankruptcy under the control of a court-appointed trustee.</br></br>
7. ‍Legal Protection: One of the most important advantages of having good buy-sell provisions in place is the legal protection and clarity they provide, reducing the risk of legal disputes and costly litigation (not only in terms of legal expenses but also in terms of time and emotional strain on the partners, and strain on the business) in the event of disagreements or unexpected changes in ownership.</br></br>
8. ‍Trust and Confidence: One final benefit is the peace of mind that comes from knowing that there is a clear plan in place for ownership changes, which are undoubtedly going to occur in one way or another if the business is enduring. Having good buy-sell provisions in force and effect from the outset will help build trust and confidence among the partners, reducing uncertainties and potential conflict for whatever the future holds in store for the company.

Having comprehensive, carefully considered, well-drafted buy-sell provisions in your company’s governance documents is crucial for any partnership business. These provisions help ensure a smooth transition of ownership, prevent disputes, maintain financial security, and protect the company’s long-term viability. If you are starting a partnership business – or if, as mentioned above, you are in an existing business but you and your partners have not thought about these issues in a while – then it is advisable for you to consult with an experienced legal professional to ensure that you will have buy-sell provisions in place that meet the specific needs and goals of your business. The attorneys at RKW are here to help you!

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