By Maurie Cashman
The buy-sell agreement is one of the most important documents that the owners of a closely held business will ever sign. This agreement controls the transfer of ownership when certain events occur among shareholders including death or disability, an involuntary termination or retirement, divorce and disputes. Last week we talked about the need to perdiodically re-allocate resources within your business. One of the resources that is often overlooked is the buy-sell agreement.
You may have a buy-sell agreement in place but your agreement many not reflect either the current circumstances of the business or your current wishes regarding business continuity. An outdated buy-sell agreement may cause more problems than having no agreement at all.
Your first buy-sell agreement was likely created when your business was just starting and was not nearly as complicated or valuable as it is today. The most significant considered was probably the death of a shareholder. If one owner wanted to leave the most reasonable response might have been to liquidate the business. An agreement addressing all events that could cause a transfer of ownership was probably not necessary or practical.
So here is the question: has your buy-sell agreement kept up with changes in your business and its owners? What events should be covered and how can and should valuation work in these agreements?
In reviewing your buy-sell agreement ask yourself the following:
- When was this document last reviewed? If it hasnâ€™t been reviewed in the last two years, it needs to be reviewed now. When you were starting out it probably wasnâ€™t critical to review the buy-sell as often because business conditions, value and shareholder objectives didnâ€™t change significantly. But today:
- business value may increase or decrease significantly from year to year;
- owners are closer to retirement or a desire to sell the company; or
- young co-owners who worked as a group during the early years now have different objectives, work ethics, and perhaps different health situations.
- When do I want to decide what the business is worth? Now or when something happens and you are under pressure and possibly dealing with a hostile environment? Decisions about how to handle these issues fairly are hard enough to make when dealing with hypothetical situations. Negotiating agreements that are fair to all parties in the midst or turmoil is very difficult and emotional. When you started your business it wasnâ€™t critical to consider how a lifetime buyout would be structured and valued because there was little value. Now your business is very valuable. Your buy-sell agreement must fully address how to cash out departing shareholders. If it doesnâ€™t or only does so based on conditions that are ten years old, you may have a big problem to deal with.
Here are a few key items to look at in your buy-sell agreement:
- Who is included in the Agreement? Who has voting control? Are there any changes in either since you last reviewed the document?
- What events are covered?
- Death, disability, business disputes and other transfer events trigger mandatory or optional buyouts. What event triggers mandatory buyouts vs. optional buyouts? Are they still valid? Should they be changed as your company has gained value and you have aged as owners? 4.
- How does your buy-sell agreement provide for the valuation of future buyouts?
- How have you funded particular types of buyouts? If there is a life insurance policy funding a buyout in the event of a shareholder death, has its value kept up with the company value? Is the policy owned by the correct party? Are the beneficiary designations correct?
- Have you adjusted the buyout agreement to reflect your current tax status? How can the buyout of a shareholder over his lifetime be pre-funded and designed to minimize overall taxes?
If your buy-sell agreement does not cover these events, you and your company may be more vulnerable than you realize.