Ever wonder what might happen if you start a business with a close friend and although the business takes off, the relationship between the two of you sours after a couple of years? Or what if you don’t know your co-founder all that well and it turns out she has huge debts and has to declare personal bankruptcy a year into your project? Or what if your co-founder has a divorce a year after launch and his ex-wife wants to take over half of the co-founder’s stake in the business?
These nightmare scenarios and others are more common than you might think. They are just the “stuff” of life. One way to avoid these headaches is to not have a co-founder, but then you miss out on all the benefits of sharing ideas, building on each-other’s strengths, and getting a team going from the start. And sometimes, you actually have a co-inventor of the business idea. So another alternative is to plan for this “stuff” and agree on a plan should the unthinkable happen – like an insurance policy against a nightmare. And just as you buy liability insurance as your business gets off the ground, you should consider getting this insurance too.
Attorneys call this type of insurance a “Buy-Sell” agreement, and it can be in the form of a stand-alone agreement between the founders or it can be a series of provisions within a larger Shareholder Agreement (for a corporation) or Operating Agreement (for a limited liability company). Typically, a Buy-Sell Agreement will arrange for co-founders to provide notice to one-another if their business equity interests are potentially going to be transferred to a third party involuntarily, and provide the unaffected co-founder the opportunity to buy those interests at a pre-determined price or formula price. And for those situations where co-founders no longer see eye-to-eye, or if one co-founder simply wants to exit the business and pursue another dream, a Buy-Sell Agreement can provide an arrangement where one founder gives a choice to the other founder: either buy me out at this set price, or I will buy you out at the same price.
These provisions can be somewhat complex, so we recommend consulting a legal professional for assistance. Entering into a buy-sell agreement upfront can save everyone involved significant heartache down the road, and provide peace of mind to focus on operating and growing the business.