Any business owner who has a partner or other type of owner as part of the ownership structure should have some type of Buy-Sell Agreement (BSA). There should be some type of agreed-upon, legally binding document that specifies what happens in case of a triggering event, such as a partner’s death, divorce, disability, firing (cause or without cause), retirement, unplanned exit, bankruptcy, criminal offense, an owner desiring to sell shares, etc.
Ideally, Buy-Sell Agreements should be written when the business is first formed (started or acquired) and when there is less value to the business versus when there is more at stake. Over a course of years or decades, there could be large increases in the company's value and most likely the opinions among the ownership group will have changed as to how one would like to be compensated for one party selling out. And once the BSA is in place, it is equally important to re-visit it and possibly update it periodically.
Among the leading items that should be addressed is how to value the ownership interest in the case of each of the above triggering events. Other important questions that should be answered include:
- Is the valuation based on a specific formula, method or someone’s opinion?
- Is the valuation based on the selection of one outside appraiser, multiple appraisers? How were they selected and what are their qualifications?
- What are the specific dates of the appraisal for each triggering event?
- Does the agreement state whether the seller receives the proceeds in a lump sum or installment payments over time? If it's a lump sum does the company have to borrow money to pay out?
- Who is the purchaser; the company or other individual owners?
- What is the allocation of the price for tax purposes?
- What happens in case of a dispute? Use arbitration, mediation or lawsuit?
- Who incurs the expense in case of a dispute? Inserting a prevailing party provision into the BSA document might be beneficial.
- Is there a discount applied for less than 50% ownership for lack of marketability or minority ownership?
- Are life insurance proceeds in place to fund the repurchase of an owner who may have died or become disabled?
Over the course of the last few months we have consulted in several situations where the Buy-Sell Agreement hadn't been looked at since the company was formed decades ago, and the fair market value of the business had changed dramatically. Depending on which side was selling or buying, one party liked the old agreement and the other party didn't. What's fair? The legally binding document signed by all owners should prevail, but the disputes can cause lost friendships and tens-of-thousands of dollars spent in legal and appraisal fees. Plus, it's very disruptive to the business.
If you don't have a Buy-Sell Agreement when a triggering event occurs and the parties can't reach a mutual agreement among all owners -- even if the triggering event is caused by one owner---all of the owners could incur frustration. So a little work early on can save a lot. Please feel free to call us for questions related to a valuation or buy-sell agreement.