Essential Tips for Creating a Rock-Solid Business Buy-Sell Agreement
By Kris Karnes, Senior Director, Business Owner Advisory Services
Uncertainties and unexpected events are part of doing business, but company owners can mitigate risks by taking appropriate actions. One way to safeguard your interests, and those of your family, is through a well-crafted buy-sell agreement.
Should the need arise to transfer ownership of your company holdings, this legally binding contract establishes a plan of action for defined circumstances, often referred to as triggers.
Buy-sell agreements are devised to minimize conflict and establish a clear path for transitioning ownership, yet some owners either fail to create a binding document or don’t thoroughly review the agreement after it is drafted.
Below are four critical topics you and your lawyer should consider when drafting your company’s buy-sell agreement.
1. Identify the Parties Involved
To avoid disruptions and misunderstandings down the line, it is essential to establish up front the parties affected by the buy-sell agreement. This usually includes the current business owners, as well as possible heirs. Business owners should talk to their business partners and family members about the solution that will best fit their needs. The buy-sell agreement should clearly outline the roles, responsibilities and benefits assigned to each party.
2. Agree on the Trigger Events
Trigger events will determine when your buy-sell agreement will come into play. Common circumstances include the death, disability, retirement or voluntary departure of a partner, but may extend to additional scenarios, such as divorce or individual bankruptcy. Clearly defining these events—and ensuring that all partners read and understand the agreement—can eliminate later conflict because everyone is aware in advance of the rights and obligations of the parties when those events occur, and of the timeframe for taking necessary action.
3. Agree on a Valuation Method
The value of a business is a critical factor when structuring a buy-sell agreement, so owners need to define the valuation method that will be used in the document. To understand how critical this is, let’s look at an example.
Say the owners of a firm agree to buy out an existing spouse upon the death of an owner, but don’t establish how the shares should be valued when making that purchase. As a result, when the time comes, the surviving co-owner may expect a discounted price for the shares or have an unrealistic idea of what the business is worth.
Outlining the method of valuation in the buy-sell agreement, whether it be fair market value, book value or a formula approach, and how to resolve any disputes regarding valuation, can help allay disagreements down the line. Additionally, this is a good time to determine how any buyout will be financed (including through insurance) and the timeframe for any payout.
4. Set Realistic Expectations and Frequently Review the Agreement Terms
Often, buy-sell agreements have provisions requiring that a request for buyout be made within 60 to 90 days after a triggering event. But it isn’t uncommon for successor owners to miss this mark. As you draft your buy-sell agreement, consider a viable timeframe. Is 90 days realistic or should you set a longer threshold?
While considering the timeline, don’t forget that all stakeholders should frequently review the terms of the agreement. This helps ensure that each is ready to act appropriately when the time comes and keeps the document up to date.
Establish Your Own Buy Sell Roadmap
According to PwC, only 34% of American businesses have a succession plan in place. Buy-sell agreements are an important piece of succession planning, offering clarity and guidance in times of transition or unforeseen circumstances.
By addressing potential scenarios, such as retirement, disability, death or disputes between partners, buy/sell agreements can offer a smoother transition, minimize conflicts and protect the interests of all parties involved. Adhering to the tips outlined above can help ensure the document you create fits the needs of the business and remains useful when it is needed.
About the Author
Kris employs her experience as former legal counsel, combined with a dedication to client success, to offer advisory services to owners considering a business transition or sale. She assesses the current situation, discusses the owner’s objectives and needs, and helps owners and their families maneuver through the emotions and decisions associated with selling or transitioning a business.
The articles in this blog are for informational purposes only and not intended to provide specific advice or recommendations. When making decisions about your financial situation, consult a financial professional for advice. Articles are not regularly updated, and information may become outdated.