Law For Small Business (Mgmt 349) Buyout Agreements (Chapter 5) Professor Charles H. Smith Fall 2010

What is a Buyout Agreement? Buyout agreement sets forth what happens if the ownership of a multi- owner business changes due to events such as voluntary departure, disability, death, or sale to or addition of new owner.

When Should Buyout Agreement be Created? Earlier rather than later – the buyout agreement should be created at the earliest possible moment (e.g., when business is being formed) since No one will have an interest in leaving or terminating the business. Little or no money is involved yet so no “greed” factor. Therefore, less chance that someone will attempt to craft a buyout agreement in his/her/its favor.

Buyout Agreements – Benefits Avoid a situation that at best is uncomfortable and at worst is catastrophic for the business – and you! Example of uncomfortable situation – you are forced to have your late long-time partner’s widow as your new partner, but you have never gotten along with her or she knows little about the business. Example of catastrophic situation – you are forced to have your late long-time partner’s widow as your new partner and she immediately obligates the partnership to several bad deals which (1) lose money and/or (2) result in lawsuits against the partnership and you personally. See page for other examples. Buyout agreement may not be necessary – see box on page 90.

Buyout Agreements – Benefits cont. Control who can own an interest in the company; e.g., give current owners (or the company itself if it is a corporation) the right of first refusal to buy departing owner’s interest. Designate the buyer for your ownership interest; e.g., “right-to-force-a-sale” clause which requires other owners to pay FMV to outgoing owner per stated method. Set a good price by specifying the method for determining the price; e.g., fair market value determination by CPA designated by agreement.

Buyout Agreement – Valuation Methods Agreeing on fixed price in advance – designate and put price in buyout agreement. This affords certainty but question as to how to determine value since it may change during life of business; examples of how determine value include Book value – assets less liabilities per most recent year-end balance sheet. Multiple of book value – for mature business; multiply same due to intangible assets such as goodwill, intellectual property and branding. Capitalization of earnings – for mature business; profits times multiplier. Appraisal – appraiser(s) designate price; can identify appraiser(s) or qualifications, or specify that each party designates (and pays for) his/her/its own appraiser.

Where to Put Buyout Agreement Corporations – bylaws. Limited liability companies – operating agreement. Partnerships – partnership agreement. Or, can be a separate document.