By Maurie Cashman
In the past two weeks we’ve looked at several key elements of your buy-sell agreement and the transfer events that can trigger a buyout. Let’s look at the types of changes that can transform that robust buy-sell you created years ago into a cumbersome and potentially dangerous relic. We’re also including a checklist that will help you assess the sustainability of your buy-sell agreement.
BUSINESSES CHANGE
The most common change in the life of a successful business is its increase in value. When the company isn’t worth much, shareholders may be able to buy each other out if certain events occur. As the company becomes more valuable shareholders cannot put together the necessary resources to buy each other out.
Over time the ownership of companies change as new owners buy in and older ones sell and retire. The ownership proportions can change in ways not intended or planned by the majority shareholders. The buy-sell agreement can respond by allowing ownership, but not voting control, to shift to the new generation of owners.
BUYOUT REQUIREMENTS CHANGE
When you created your buy-sell agreement, you made decisions about whether particular events would trigger an optional or a mandatory buy out. You made those decisions based on the circumstances at that time. As circumstances have changed you may not have changed in response. For example, you may now have a child or a key employee that you want to acquire your ownership when you retire or die, rather than the other co-owner.
PEOPLE CHANGE
Shareholders will age and change. As they do, they may adjust what goals they want to achieve or how much they want to work. If shareholders are all similar in age, they may share these changes or they may not. If one shareholder is older than the others, the commitment to work long hours or the long-term ownership goals of the older and younger shareholders can diverge. If that happens, the only solution may lie in the terms of a well drafted, comprehensive and current buy-sell agreement.
THE ABILITY TO SELL OUT CHANGES
When your company was not worth much, it would have been unlikely that an unrelated third party would approach you with an offer to buy. Now that your company is more valuable the possibility that a third party would make an offer is realistic. Does your buy-sell agreement adequately address this? What if one owner wants to sell and the other doesn’t? Does it make a difference whether you are the owner who wants to sell or the owner who doesn’t want to sell?
INDUSTRIES CHANGE
The industries we are in affect the value of our companies. If you’re re in a niche or hot industry, buyers will pay more for your company. If there is significant industry consolidation occurring the value of your company will reflect that. Industries also go through boom and bust cycles and if the company is enduring the bust part of the cycle, its value reflects that downward pressure. Buy-sell agreements can be drafted to manage rapid changes in value and corresponding changes in the terms (length of buyout, amount of down payment, mandatory vs. optional purchase, etc.) of any purchase. This tends to prevent one owner from timing the buy-sell agreement by selling out when value peaks.
Given all the moving parts, it makes sense to review your buy-sell agreement at least every year. The following checklist is designed to give you and your advisors a snapshot of your buy-sell agreement. The purpose is to help you identify those areas that should be updated for all the reasons discussed here.
Buy-Sell Transfer Event Checklist
Death of a Shareholder:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Disability of a Shareholder:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Divorce of a Shareholder:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Bankruptcy of a Shareholder:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Retirement of a Shareholder:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Involuntary Termination of Employment:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No
Business Dispute Among Owners:
Is it included in the Agreement? Yes No
Buyout: Mandatory or optional Mandatory Optional
If buyout can be funded, is it? Yes No
Is the funding adequate? Yes No
Is the ownership proper? Yes No