Free Legal Updates at Nolo.com NOLO ® • Create a legal exit strategy • Keep your business safe • Protect your interests Plan Now for Retirement, Death, Divorce or Owner Disagreements Business Buyout Agreements Bethany Laurence, J.D. & Attorney Anthony Mancuso “Business Buyout Agreements takes you through it, step by step ” ACCOUNTING TODAY 5TH EDITION A L L F O R M S O N C D - R O M L F O F O F R M S N C D - R O M e Story Dear friends, Founded in 1971, and based in an old clock factory in Berkeley, California, Nolo has always strived to off er clear legal information and solutions. Today we are proud to off er a full range of plain-English law books, legal forms, software and an award-winning website. Everything we publish is relentlessly researched and tested by a dedicated group of in-house legal editors, who together have more than 150 years’ experience. And when legal changes occur after publication, we promptly post free updates at Nolo.com. 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LAURENCE Book Design TERRI HEARSH Proofreading ELAINE MERRILL Index MEDEA MINNICH Printing DELTA PRINTING SOLUTIONS, INC. Mancuso, Anthony. Business buyout agreements : plan now for retirement, death, divorce or owner disagreements / by Anthony Mancuso & Bethany K. Laurence. 5th ed. p. cm. ISBN-13: 978-1-4133-1195-2 (pbk.) ISBN-10: 1-4133-1195-4 (pbk.) 1. Sale of business enterprises Law and legislation United States Popular works. I. Laurence, Bethany K., 1968- II. Title KF1659.M36 2010 346.73'0652—dc22 2009040465 Copyright 1999–2010 © by Anthony Mancuso and Nolo. All rights reserved. The NOLO trademark is registered in the U.S. Patent and Trademark Offi ce. Printed in the U.S.A. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise without prior written permission. 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Also, sincere thanks go to Mike Mansel for reviewing the funding and insurance chapter and to Walter Gibbons for lending a keen eye to the tax law chapter. Dedication To Jason, who became my husband somewhere in between the second and third drafts, without whose warm support and tireless tolerance I might not have finished this book. —BKL About the Authors Anthony Mancuso is a corporations and limited liability company expert. He graduated from Hastings College of the Law in San Francisco, studied advanced business taxation at Golden Gate University in San Francisco, and is an active member of the California State Bar. Mr. Mancuso is the author of Nolo’s bestselling titles on forming and operating corporations (both profit and nonprofit) and limited liability companies. His titles include Incorporate Your Business, How to Form a Nonprofit Corporation (national and California editions), Form Your Own Limited Liability Company, The Corporate Records Handbook, and LLC or Corporation? He researched, wrote, and programmed LLCMaker and Incorporator Pro software programs, published by Nolo, which generate state-by-state articles and other forms for organizing corporations and LLCs in each of the states. His books and software have shown more than a quarter of a million businesses and organizations how to form an LLC or corporation. He also is a licensed helicopter pilot and has performed as a guitarist in various musical idioms, including jazz and blues. Bethany K. Laurence joined Nolo as a legal editor in 1997. She holds a law degree from University of California, Hastings College of the Law, a B.A. degree from Boston University (Phi Beta Kappa, magna cum laude), and is a member of the California State Bar. Ms. Laurence has combined her legal and financial expertise to edit many Nolo books over the years. She is the co-author of Save Your Small Business: 10 Crucial Strategies to Survive Hard Times or Close Down and Move On and Bankruptcy for Small Business Owners: How to File for Chapter 7. Over the years she has been the editor of Form Your Own Limited Liability Company, Tax Savvy for Small Business, and The Small Business Start-Up Kit, as well as co-developer of Nolo’s Online LLC and Quicken Legal Business Pro software. Prior to joining Nolo, Ms. Laurence worked as an electronic product developer at CCH, Inc. (a division of Wolters Klewer, Inc.), where she created legal online and CD-ROM products. Over the last decade she has been active on the board of directors of several local environmental and educational nonprofit organizations. Table of Contents Introduction Your Legal Companion for Creating a Buyout Agreement 1 An Overview of Buyout Agreements What a Buy-Sell, or Buyout, Agreement Can Do 8 When Should You Create a Buyout Agreement? 16 Does Everyone Need a Buy-Sell Agreement? 17 How to Create Your Agreement 18 When to Seek a Lawyer’s Advice 20 2 Limiting the Transfer of Ownership Interests Transfers of Ownership Interests 24 Using a Right of First Refusal 25 Using Absolute Transfer Restrictions 43 3 Providing the Right to Force Buyouts Changes in an Owner’s Circumstances 48 If an Owner Retires or Stops Working 52 If an Owner Becomes Disabled 65 If an Owner Dies 74 If an Owner Divorces 88 If an Owner Loses a License 93 If an Owner Files for Personal Bankruptcy 96 If an Owner Defaults on a Personal Loan 99 If an Owner Needs to Be Expelled 104 4 Structuring Buyouts Company Versus Co-Owners as Buyers 110 e “Wait and See” Approach Works 115 5 Funding Buyouts Funding With Cash 134 Borrowing Money 135 Buying Insurance 135 Making Installment Payments 149 6 How to Set the Buyout Price in Your Agreement Why Choose a Price in Advance? 152 What Valuation Methods Are Based On 154 How Our Valuation Provisions Work 157 Agreeing on a Fixed Price (Valuation Method 1) 159 Using a Buyout Formula 164 7 Choosing Payment Terms for Buyouts Balancing the Interests of Buyer and Seller 188 Lump-Sum Cash Payment 190 Installment Plans 191 Customized Schedule of Payment 197 Creative Ways to Pay 198 8 Completing and Updating Your Buyout Agreement Finalizing Your Buyout Agreement 202 Resolving Buyout Disputes in the Future 212 Binding Future Owners Under Your Buyout Agreement 222 Updating Your Agreement 223 [...]... to Create Documents 284 Forms CD-ROM .287 B Buyout Worksheet C Buyout Agreement Index Your Legal Companion for Creating a Buyout Agreement A ny new business owner knows there is an insane number of tasks involved in launching a business Just getting your business license, government filings, and finances in order can wear you down, never mind readying the heart of your business: ... process for creating a buyout agreement that makes sense for your business, will help you relax and get to the good part: making your business a success ● 1 C H A P t e r An Overview of Buyout Agreements What a Buy-Sell, or Buyout, Agreement Can Do .8 Guarantee a Buyer for Your Ownership Interest 9 Control Who Can Own an Interest in the Company .11 Set a Price for a Buyout ... Payment Method for a Buyout 14 Fund a Buyout 15 Tying It All Together 16 When Should You Create a Buyout Agreement? 16 Does Everyone Need a Buy-Sell Agreement? 17 How to Create Your Agreement 18 When to Seek a Lawyer’s Advice 20 6 | Business Buyout Agreements T he first days and months of a new business are busy... discuss funding buyouts further in Chapter 5 16 | Business Buyout Agreements Tying It All Together It is your job (along with your co-owners) to decide which of these provisions you want to include in your buyout agreement After reading the first part of this book, which explains the various buyout options mentioned above and how they can be used, you and your co-owners will choose the buyout provisions... exit plan, if you want out of the business in three years, you might have to leave your money and hard work behind And without buyout provisions, what if a coowner, out of the blue, threatens to liquidate the company if you don’t meet a buyout price you can’t afford—who wins? To avoid disagreements (maybe even lawsuits) and keep the business going smoothly, you need a buyout agreement that spells out... ownership transition occurs You might want to think of a buyout agreement as a type of prenuptial agreement Just as a prenup specifies what will happen to shared property if one spouse wants out of a marriage, a buyout agreement lets everybody know what 2 | Business buyout agreements each owner’s rights will be if someone wants or needs to leave the business Nobody has to worry about, or fight about,... difficult to sell a less-than-100% share of a small business A minority share gives an owner little or no control over how the business is run Think of it this way: If your dream has been to own and run your own business, would you be likely to settle for a tiny piece of someone else’s? Probably not—if you are like most people 10 | Business Buyout Agreements The Solution If the time comes when you... owner dies We discuss these options in Chapter 2, “Limiting the Transfer of Ownership Interests,” and Chapter 3, “Providing the Right to Force Buyouts.” 14 | Business Buyout Agreements Set a Price for a Buyout An important part of adopting a well-thought-out buyout agree ent m is setting a price at which ownership interests will be transferred Without having an established price for the company in... to allow an owner to request a buyout • when a buyout should be required (for example, after disability, divorce, bankruptcy, retirement, or death) • how to restrict who can buy into the company • how to value the business and each owner’s share • how to set up payment terms to make future buyouts affordable, and • how to provide the funds for future buyouts Creating a buyout agreement may sound like... Chapter 1 | An Overview of Buyout Agreements | 19 the following major issues that will help you decide on the terms of your buyout agreement: • how to put limits on to whom an owner can transfer his interest (Chapter 2) • how to provide for forced buyouts in certain circumstances (Chapter 3) • how the procedure works for buyouts in the future (Chapter 4) • how to fund future buyouts (Chapter 5) • how . 20 C H A P t e r 1 An Overview of Buyout Agreements 6 | BUSINESS BUYOUT AGREEMENTS T he first days and months of a new business are busy times. The last. for Creating a Buyout Agreement 1 An Overview of Buyout Agreements What a Buy-Sell, or Buyout, Agreement Can Do 8 When Should You Create a Buyout Agreement?