How do you avoid disputes and litigation over a buy-sell agreement in the event of a partner's death?

To minimize disputes and avoid litigation under a buyout agreement in the event of a partner’s death, several key strategies should be implemented. First, it is important to clearly define the terms of the buyout, including the valuation of the business. Using an independent appraiser when drafting the agreement can reduce the likelihood of conflicts. Second, the agreement should provide a mechanism for financing the buyout, such as life insurance, to ensure that the heirs have funds to purchase the share. In addition, regularly reviewing and updating the agreement based on changes in the market situation and the ownership structure will help avoid misunderstandings.

Ensure life insurance funds the agreement, establishing liquidity. Incorporate a valuation formula avoiding ambiguity. Use a neutral third-party for mediation clauses to preempt conflicts. Implement regular partner workshops for understanding and agreement updates. Periodically stress-test scenarios with advisors to anticipate potential disputes.

This is critical in a stand alone buy-sell or in an operating agreement. One of the many reasons a 50/50 operating agreement is unadviseable is the difficulty in breaking deadlocks. Independent valuation of a private business is difficult but a necessary mechanism for all parties to accept even if parties pick an agreed upon value because that value can get stale. Sometimes, buy-sells include an every five year parties to agree on new value mechanism plus the independent FMV valuation but without a funding mechanism only one part of this critical conversion is being addressed.

Ensure the valuation method accounts for both current and projected earnings to reflect true business value. Use an industry-specific EBITDA multiplier to keep valuations relevant. Engage an independent valuation expert periodically to maintain objectivity. Establish a predefined dispute resolution mechanism, such as binding arbitration, to swiftly handle valuation disagreements.

To prevent disputes and litigation after a partner's death, integrate life insurance into the buy-sell agreement. Each partner is insured with the other partners or the business as the beneficiaries. If a partner passes away, the life insurance payout is used to buy out their business share based on a previously agreed valuation. This method ensures that the deceased partner's family is compensated promptly and fairly, alleviating potential financial burdens on the business or other partners. It provides a clear, financially viable process for transferring ownership, securing business continuity, and preventing conflicts between surviving partners and the deceased's heirs, all within the framework of the agreed terms.

Life insurance is often discussed but unfortunately underbought. The cost of insurance is often prohibitive the longer parties wait. The business could create a sinking fund that could double as a deferred retirement fund if sufficient cash exists BUT the members/owners must really exercise their duty to their families and each other to properly fund. Otherwise, when a key person dies or is disabled, their major asset - now unfunded - simply fails.