02 May Objectives of Buy-Sell Agreements
The business planning process can be a real beast. As a necessary evil, however, it can simultaneously protect owners and the company itself from financial ruin and volatility in the event of drastic events, both planned and unplanned. With that in mind, here are a few general objectives in crafting a buy-sell agreement for your business.
Control the business control
Sounds redundant, but business owners need to effectively control who gets in. This provision provides that ownership interest never becomes available to third-parties who the owners may find completely unacceptable.
Unless your business is had by a “golfer” owner, maintaining control with a buy-sell in this way may not be a huge deal. For most other organizations it can prove destruction down the road. Such destruction is usually triggered by some event like death, bankruptcy, divorce, etc. which can open up equity interest in the company to initially-unintended parties. Including this provision in the buy-sell agreement is absolutely essential.
The mantra “proper planning prevents piss poor performance” is fitting here. Unless your business is adequately prepared for disruptions in the future, the company could go under. Mitigating volatility in business management is greatly about smoothing through transitions and disastrous times. Important suppliers, key employees and even long-time customers can all have anxieties when your boat is rocked.
Be sure your buy-sell agreement smooths concerns as much as possible so your business continuity is maintained. Prepare for the worst, plan for the best and expect somewhere in between.
Keeping things fair
I love the oft-quoted phrase attributed to Warren Buffett, “price is what you pay, value is what you get.” Maintaining fair prices for equity interest of departing owners is critical. Divisive negotiations at the time of departure are destructive to the company and can be even more detrimental to the relationships that tie the company together.
A proper buy-sell agreement will apply fairness to all its provisions across all owners and stakeholders. It will predict problems and crisis, be very clear and fair in its approach. In short, everyone should feel like it’s a good deal.
FMV of shares
Along the lines of keeping things fair, any buy-sell agreement should clearly define the fair-market-value (FMV) of shares and define such at the appropriate points of exit. Without clear definitions, there may be no internal or external market for company shares. This problem makes selling such, either to internal owners/employees or external investors, nearly impossible.
A carefully structured, written and funded buy-sell agreement will define FMV of company shares, helping to assuage the risk inherent in trigger events when the shares need to be bought by the company or its owners.
Involuntary termination of one or more owners is never a fun task, but can be a necessary duty of other stakeholders if a particular owner is no longer wanted. Ensuring the buy-sell agreement includes rights and triggers for involuntary expulsion will be important in maintaining the business longevity, even if friction occurs between owners.
While expulsion rights may not matter for the “golfer” shareholder, they are extremely important to the worker/toiler companies, professional organizations and most hybrid companies.
Anticipating the cash needs of any business can be difficult. Knowing how that will come to bear in a buy-sell trigger situation therefore needs to be assigned in the buy-sell agreement. Funding options for buy-sell agreements, including life and disability insurance can play a huge role in ensuring cash levels are maintained for funding operations. Most important is determing how the buyout will be funded.
Estate tax exposure
There are very few business owners who wish to pay more than their fair share in estate taxes when their shares of any business are sold. This can occur, however, if deceased owner’s equity interests are not properly valued prior to the death trigger. Being forced to pay estate taxes on a value greater than that received by the company in the event of a death trigger is not ideal.
Being and entrepreneur can be one of the most exhilarating rides any business owner will ever experience, but without proper planning, the company may find itself in dire straights down the road. Avoid partnership issues in buyout scenarios by following the aforementioned steps for drafting your buy-sell agreement.