Entrepreneurs, family-owned, and closely-held businesses are often so busy running the business that they can overlook good operating habits and sound business practices. When everyone is friends or family, it’s easy to take things for granted. Business owners often think that someone close to them would never misunderstand an arrangement that was discussed, take advantage of some misfortune by an owner or partner, or, in the case of a key employee, leave the company because they have no vision of possible ownership of the business.
However, these things can and do happen.
But here’s the good news: If you’re not currently prepared for such a scenario, it’s never too late to make an adjustment midstream.
Take the case of Bob and Carla, two friends who worked for a company and left to start their own business together as equal owners. Over time, the business prospered and grew. While Bob took care of production and administration, Carla made sales calls and pitched in when needed to make sure that the product was shipped in a timely way. Their employees were paid a fair wage and Bob and Carla made a comfortable living.
Everything was running smoothly…until Bob, who was 15 years older than Carla, decided to retire. Carla had always promised Bob that she would buy him out when he was ready to retire. The price she would pay him, though, was never mentioned. And when retirement time came, the price Bob requested for his share of the business was 30 percent greater than any textbook measurement suggested was reasonable. All of a sudden, Bob and Carla were at odds.
What should they have done differently to prevent this situation? Long before retirement became a reality, Bob and Carla should have sought counsel and adopted a written buy-sell agreement. A buy-sell agreement is a legally-binding contract between a business and its owners, and includes many of the following elements:
- A description of the circumstances that will trigger the agreement, including, but not limited to, age of retirement, a predetermined election of owners, death, disability, bankruptcy of an owner, or criminal acts by an owner.
- A predetermined price for the business, either based on a preset formula intended to approximate market value, or a valuation prepared by an independent valuation expert. In some cases, it may be arbitrated by a third valuation expert if the agreement requires two appraisals and they are different by some predetermined percentage or amount.
- Terms for the required payment of the price established by the agreement.
- In the case of disability, a specified length of time a party cannot work and independent medical confirmation of permanent disability.
- The array of options for the remaining owners of the company who are purchasing shares.
What are the benefits of a buy-sell agreement?
- Owners can continually assess the potential economic exposure of a buyout event.
- Proper consideration can be given to insuring the cost of unexpected triggers, including death and disability.
- Those who are, or become, equity owners have a clear understanding of the terms and valuation mechanics for intra-owner equity or business enterprise mandated transactions.
- The agreement provides objectivity during the transaction.
Time is only critical if a business lacks proper buy-sell coverage. If you don’t already have one, make the time to remedy the situation as soon as possible.
Timothy C. Hilbert can be reached at Email or 215.441.4600.
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