The most important business planning document that multiple owners of a business can have is a buy-sell agreement. A buy-sell agreement provides direction to owners and other stakeholders when certain events trigger the transition of an ownership interest in a business.
These agreements can be very effective in minimizing uncertainty and indecision during challenging and emotional times. However, it’s not enough to simply have a buy-sell agreement, it needs to be written skillfully to accomplish the desires and goals of the owner(s).
Buy‐sell agreements, in some situations, can create as many questions, problems, and conflicts as they seek to address. A primary benefit of having this agreement is to avoid having to make decisions that could lead to disagreements at an inopportune time. Unanswered questions, outdated agreement language that no longer represents the goals of the owner(s), an agreement that is not comprehensive and too simplistic or was poorly implemented can render the buy‐sell agreement ineffective and fail to accomplish the intended purpose.
Opening questions:
Do you need a buy-sell agreement, and if so, do you have one?
Is your buy-sell agreement outdated? When was the last time your agreement was reviewed to ensure that it still well represents your goals?
Will your buy-sell agreement cause more problems than it would solve in its current form?
Too often buy-sell agreements have one or more of these planning gaps:
Ignores lifetime trigger events such as divorce, bankruptcy, voluntary exit, and involuntary exit.
A simple valuation method that does not consider the ever-changing dynamics and growth of the business.
The timing of valuation is not adequately addressed.
When buy-sell agreements are not regularly reviewed, they can become outdated and result in unpleasant surprises when they are needed. Owners rely on Buy-Sell Agreements to manage emotional situations, and if those agreements don’t account for changes in their goals as well as the business, they can cause significant problems for everyone involved.
Many buy-sell agreements are too simplistic to manage the personal complexities of the individual owners who sign them, and their relationships with each other. For example, companies with multiple owners often don’t want to treat all owners similarly, or one owner subject to the agreement may be uninsurable. In family businesses, non-business considerations may affect the design of buy-sell agreements.
Fails to address threats to business continuity. Most buy-sell agreements don’t address the challenges that the business, surviving owners, and deceased owner’s family will face after an owner exits. Too often they only address the transfer of ownership upon an owner’s death or permanent incapacitation. For example, if the surviving owner does not have enough assets to satisfy the personal guarantees previously made by the deceased owner, once that financing is pulled, the business may not be able to continue. Likewise, if the deceased owner was the company’s rainmaker or COO and no one can step into those roles, the business may be unable to survive.
Buy-sell agreements are typically deficient in considering the financial security of the decedent’s family.
Questions your buy-sell agreement should answer include the following:
Are “lifetime triggering events” addressed as well as death and disability? Divorce? Bankruptcy? Voluntary exit? Involuntary exit?
What type of valuation estimate is required? Book value? Fair market value? Fair value? Investment value? Agreed upon value?
What is the desired timing for the value calculation? Date of the trigger event? Subsequent event?
Does the entire business need to be valued, or a partial ownership interest?
What method of funding will be used to complete the transaction?
Cash – Requires sufficient cash flow or reserves to pay the full sale price in a lump sum. May not be available when needed.
Loan – Future credit availability and cost of borrowing are factors.
Installment Sale – Requires repayment from earnings and is contingent upon the future growth and success of the business.
Insurance – Provide liquidity when needed for either death or disability trigger events.
Should the buy-sell agreement method of funding be taken into consideration in the value?
What method will be used for valuation? Fixed price? Formal valuation? Formula-based?
Is there clarity as to what is mandatory and optional regarding the purchase or sale of an ownership interest?
What goals for your spouse and family do you want to be realized if you die, become incapacitated, or otherwise exit the business unexpectedly?