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Buy-Sell Agreements for Privately Held Businesses
The worst time to negotiate a business sale is when the owner has died, and the owner’s family or ex-spouse is attempting to gain control. If the business has a buy-sell agreement in place, the transfer of equity from one owner to another, even at the time of a dramatic trigger event, will be smoother and less contentious.
A buy-sell agreement serves several functions:
- Defines an exit strategy for the owner
- Provides for business continuity to the next generation or a chosen next owner
- Manages tax liability for the seller, and
- Prepares the business in the case of an unexpected event, including death, divorce, disability, or a disabling mental illness.
A buy-sell agreement should be created when all parties are actively engaged in the negotiations. It should be designed to work with the estate plan for the business owner. In many cases, the buy-sell agreement is a substantial part of the estate plan. The agreement will require the services of an attorney, a CPA and a business valuation expert, who might be a CPA with special accreditation in business valuation.
The language must be clear and specific to avoid interpretations that could lead to litigation. Similar to a divorce agreement, it is wise for each party to have the agreement reviewed by independent attorneys to eliminate any potential conflicts of interest. Litigation between the parties in the future will cost far more than the cost of a thorough and well-crafted buy-sell agreement.
The buy-sell agreement must have an accurate and agreed-upon valuation of the company. Terms like “fair market value,” “market value,” or “book value” are general terms and are not adequate. There are many different ways to value a business, and all must agree on how this is to be done.
Maintaining Your Buy-Sell Agreement and Planning for the Unexpected
Like an estate plan, a buy-sell agreement requires upkeep. A good rule of thumb is to have the business obtain a certified valuation from an appraiser on an annual basis. If this seems like an unnecessary cost, consider the cost of litigation. It will be higher than an annual valuation.
Buy-sell agreements also restrict outsiders or unwanted business partners from being involved in the business. This is especially important for family businesses. The stakes are high, when it comes to preventing ownership battles from in-laws, ex-spouses and others.
Additional provisions to include:
- Right of first refusal
- Valuation clause requiring ongoing valuations by an accredited professional
- Deadlock provisions to allow the owners to dissolve the business at any point, and
- Terms of the financing and payout, interest rates, business value and timing.
There should also be a plan in place for what would happen, if the owner elects not to go forward with the agreement.
Tax planning needs to be part of a buy-sell agreement to protect the seller’s profit. Many buy-sell agreements provide for the payments to take place over a period of years to soften the tax liability.
Remember, a buy-sell agreement created with an end-date ten years in the future must also work if a triggering event occurs and the agreement must be used within six months of its date of execution.
Preparing for the sale or transfer of a privately held business provides a sense of security and continuity for all involved. Key stakeholders appreciate the investment, confident that their efforts will not evaporate, if an unexpected event occurs. Family members who depend upon the business for income may not be directly involved with the succession plan, but the security it creates is appreciated.
How Intrusive and Time Consuming will Creating the Business Succession Plan Be, and What Will It Cost?
These are the bottom-line reasons that business owners do not like succession plans. The cost must be understood as an investment in the future of the company. Intrusion is a real problem in companies where teams do not work together or there is infighting among departments. The business succession plan forces these issues out into the open. Bringing internal issues to light, especially if they are deeply embedded in the culture of the company, could be the difference between the company surviving through a change of ownership and having it implode for reasons the owner and the heirs of the owner could never otherwise anticipate.
Just as every high-net worth individual needs a comprehensive estate plan, so, too, does every business. This is true whether the goal is to continue the company or sell it for the highest possible price. If you are a business owner, then take steps now to complete (or update) and coordinate your personal estate plan with the estate plan for your business.
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