As the business owner’s average age continues to increase given the demographics of our
population, there are a number of issues that may not have been perceived as
important a few years ago that gain increasing attention as time marches
on. The truth is that these issues (e.g. buy sell-agreements, business continuity plans,
etc.) have always been important. There are a number of ways one can exit
his/her business. Many of those exit plans are voluntary and planned
while some are not. These agreements are often times overlooked as there
is no sense of immediate need/urgency, etc. They also generally deal with
less than pleasant scenarios that people prefer not to think about. The
reality is that if you want to take care of your spouse and children, you
really need to think about how your business is going to produce a liquidity
event, in a timely, efficient and fair (think valuation and terms) manner so your family
can be well taken care of. It can also be helpful to you as a shareholder
if for some reason you find yourself, or your partner, having to divest from
the business for whatever reason.
In basic terms,
buy-sell agreements deal with situations whereby a business owner leaves the
business through death, incapacitation or some other unexpected set of
circumstances. These agreements are also important in that if your
partner is the one who is unexpectedly unable to continue in the business, the
buy-sell agreement is the vehicle which will preclude his/her spouse from
becoming your business partner. This last item alone can be very
motivational for business owners to address this issue.
Some of the key terms
addressed via a buy-sell agreement include who may buy the business interest,
the events that trigger the agreement and the price to be paid for the business
interest. All of these are very important elements and must be addressed
thoroughly and with professionals who are expert in preparing such
agreements. There are a few major, critical considerations which also
must be addressed when structuring buy-sell agreements; 1) valuation criteria
and 2) properly funding the buy-sell agreement.
The valuing of a
business, or a share in a business, is an undertaking that can produce varied
results. I’ve said many times over the years you can have one valuation
expert arrive at different valuations for different purposes (there are a
number of reasons a company may need to obtain a valuation) at the same point
in time. You can also have different valuation firms arrive at very
different results all valuing the business for the same purpose at the same
time. The best way to mitigate the potential for an unexpected and/or
unfair result is to hire valuation experts familiar with your industry and
business. One size does not fit all when it comes to valuation and the
selection of the right valuation firm is critical. Valuation is contingent
on many factors including methodologies, styles and perspectives, who the
valuation firm is hired by (buyer or seller), etc. Within the context of
a buy-sell agreement, valuation is further challenging in that the principals
are not necessarily looking for a value today, rather the goal is to ascribe a
value to a business, or share of a business, at some unknown point in the
future.
The best way to handle
the valuation issue in a buy-sell agreement is to have a valuation performed in
the first year and then get annual, less expensive updates to that valuation in
subsequent years. Using this process, the many variables associated with
properly valuing a business can be addressed given the set of conditions
present at that time. It is impossible to build a formula that will
successfully process all of the variables that can change in the future.
That being said, in addition to building in a valuation requirement, it makes
sense to insert a formulaic approach into your buy-sell agreement if for some reason
a valuation wasn’t performed at the scheduled time(s) as a backup safety
valve. A dynamic formula is better than none at all and can be critical
in the absence of a valuation being performed. Arriving at a fair value
for the business is essential to ensuring you and your family’s interests are
protected.
Another important
consideration in structuring buy-sell agreements is the funding of the
liquidation event. Depending on the particular set of circumstances,
there are a variety of ways to fund buy-sell agreements so that the business is
not disrupted. Also, insurance can be an effective tool serving as value
preservation in the event that the loss of a key individual adversely affects
the valuation of the business. Generally speaking, there are a number of
insurance products used to fund the buy-sell agreements so that the business
has the liquidity it needs to pay out the proper value of the business to the
appropriate parties.
If you would like assistance in reviewing the terms of your buy-sell agreement and/or developing the funding model, please do not hesitate to contact me.
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