Post 6
This series focuses on “business divorce,” the break-up of a business between business owners due to disagreement or other circumstances. A business break-up leads to either one owner continuing the business without the other owner, the forced sale of the business to a third party, or a total dissolution or winding up of the affairs of the business. Because the situation can be contentious, it may lead to unnecessary litigation. Shutting a business is often not a viable option, so it may be better for one member to either buy out the other member or sell its stake to the other member. Thus, it may be good for business owners to think ahead, discuss, and consider preparing an exit plan where one business owner may exit sooner than the other, in effect like a business prenuptial agreement.
This will be a multi-post blog entry. Our earlier post mentioned various options that business owners may choose from in case of a disagreement upon one owner’s exit relating to certain aspects of the business. Our earlier post can be found here at our website — www.mcbrideattorneys.com. This sixth post discusses different Buy-Sell Options that business owners may explore where one owner chooses to buy the ownership interest of the other business owner.
Post 6 – Different Buy-Sell Options
Simply put, a Buy-Sell Option is where one business owner proposes to buy the ownership interest of the other business owner, resulting in the removal of a person as the owner of the business. The objective of such provisions is “to have in place a mechanism that will treat the [business owners] fairly while at the same time allowing the business to continue.[1]” Typically in a joint venture or a multi-owner situation, the Buy-Sell Option type is predetermined and may come into effect upon the occurrence of certain events (e.g., deadlock over specific matters). The purchase price depends on the type of Buy-Sell Option that owners choose, which may include some of the following (among others):
- Texas Shootout: In this type[2], both business owners send their sealed bids to a third party on a per share/unit basis or with an entity price. The highest bidder wins.
- Russian Roulette: In this type[3], one business owner notifies the other owner of a price at which the first owner wishes to buy out the entire portion of the second owner’s shares. The second owner has to decide to either sell out at the notified price or buy out all of the first owner’s shares at that same price.
- Dutch Auction: In this type, each business owner submits its sealed bid with a minimum price at which they may sell. The business owner whose minimum bid is higher, wins – causing the lower bidder to sell out at the lower quoted price.[4]
- Regular Auction: The business owners may hold a regular auction where each owner is allowed to bid for the entity openly on a per share basis. The highest bidder wins.
- Adjusted Fair Market Value: Business owners have a neutral third party conduct the entity’s valuation. Subsequently, “the [business owner] triggering the buy-sell provision will either buy the other [owner’s] shares at a set premium (e.g., 20%) or sell its shares to the other [owner] at an equivalent discount.[5]”
One of the main advantages of a Buy-Sell Option is that it provides a quick mechanism for a deadlock. It has disadvantages, however, including that the business valuation could be flawed; the timing for a company’s sale may not be appropriate; and one business owner may not have liquidity to buy out the other business owner, impacting the true value of the business and prejudicing one or the other business owner. However, in options 1, 2, and 3 above, because the owner/bidder runs the risk of selling themselves out at the quoted price, these methods may help ensure the price quoted by each owner is fair and reasonable.
Our next post will focus on alternative dispute resolution, or ADR, when a Buy-Sell Option is not available and/or co-owners are unable to reach an agreement.
This posting is intended to be a planning tool to familiarize readers with some of the high-level issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your transaction planners including attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
[1] Chadbourne & Park LLP, Mergers & Acquisitions Client Alert: ‘Til Deadlock Do Us Part, http://www.chadbourne.com/files/Publication/c32eedff-a3b9-45be-bb78-fb509db40ef8/Presentation/PublicationAttachment/24322a69-d996-499c-a474-fc28ab56fdbf/MandA-TilDeadlock_ca(Greason).pdf (last visited Jan. 29, 2015).
[2] See Practical Law, Texas Shoot Out, http://us.practicallaw.com/1-107-7385?source=relatedcontent (last visited Jan. 29, 2015).
[3] See Practical Law, Russian roulette, http://us.practicallaw.com/3-107-7186 (last visited Jan. 29, 2015).
[4] See supra n. 1.
[5] Id.