Time to make buy-sell agreements a priority
November 21, 2019
By Rob Leibfried, CPA, ABV
Buy-sell agreement? You know, that legal agreement you probably signed 20 or 30 years ago and filed away with the Articles of Incorporation, by-laws or other legal documents? That's the one.
Let's be honest, buy-sells always have been important. Unfortunately, the majority of business owners simply have not treated them as such.
To be fair, when you signed your agreement into existence, you probably thought your duty as responsible business owners was fulfilled. After all, you went through the process of putting an agreement in place, all the owners of the business were satisfied with the agreement, and you discussed the agreement with your attorney and your CPA. What else is there to do?
Well, here is your warning: Heraclitus taught us that change is the only constant, and businesses and business owners change as well. What once might have been a viable agreement might be a ticking time bomb waiting to go off. What's worse, you could be legally bound to its terms. How many of us can even recall the terms of our buy-sell agreement? It's a scary thought.
If that doesn't have you digging through the filing cabinet, consider this: 76% of baby boomers (who collectively own 63% of private businesses in the U.S.) plan to transition the business to the next generation during the next 10 years. Fifty percent of American marriages end in divorce. And 100% of business owners will eventually die. All of these are situations that could - or rather should - trigger your buy-sell agreement into action.
While most of us probably think we'll be well out of the business before death is knocking on our door, the point is there already is a good possibility your buy-sell agreement eventually will be triggered into action. Add to it an increasing number of business owners reaching retirement and new business owners being brought in, and the probability your buy-sell agreement is triggered increases exponentially.
Most business owners are no strangers to legal contracts. Some might use them regularly whether they are in the form of a supplier contract, a customer contract or a real estate lease. Most business owners review and revisit these types of agreements far more regularly than their buy-sell agreement.
Why is this? It's true these contracts are more relevant to the regular operating cycle of a business, but the repercussions of a misunderstood buy-sell agreement are likely no less substantial. In some cases, the mere continued existence of the business might be at risk, as would be the livelihood of the company's owners, employees and their families.
So, what can business owners do to protect themselves? First, do not make the costly mistake of assuming this will not happen to you. The time and cost of regularly reviewing your buy-sell agreement is nominal compared to the time and cost incurred when the ticking time bomb that is your buy-sell agreement goes off.
All businesses with multiple owners should have an executed buy-sell agreement. It does not matter if it is a family-owned business or if it's an ownership between unrelated parties.
Other points of emphasis:
- Discuss your buy-sell agreement with an accredited valuation expert. Valuation experts are some of the first people called when buy-sell agreements go south. For this reason, they are uniquely adept at identifying problem areas in buy-sell agreements before they happen. We've seen them all.
- Value your business on an annual or biennial basis. While there might be many issues with a buy-sell agreement, most are ultimately uncovered because of a disagreement centered around value. Signing an annual "certificate of value" to memorialize the value at the beginning of every year can be a great way to ensure everyone understands the repercussions of the buy-sell agreement and has agreed to a pre-determined value up front. Again, discuss the business' value with an accredited valuation expert. Often, the business' value can be routinely recalculated fairly efficiently and for a fraction of the cost required in legal dispute settings. Aside from memorializing the value of the business for the buy-sell agreement, numerous other benefits exist to routinely valuing your business (some of which I have previously described in my article, "The power of knowing the value of your business."
Buy-sell agreements are put in place to control potential changes in the ownership of your business in order to protect the business and to protect the owners.
If you do not know how your buy-sell agreement will impact your business when triggered, you are inviting uncertainty into your future and the future of your business. Take back control and make sure your buy-sell agreement is operating the way you intended it to.
This article was previously published in the Tri-State Business Times.