Buy-sell agreements govern the purchase and sale of business ownership interests when death, disability or other significant events happen. However, such agreements generally lack in three critical areas.
Three areas that cause most concern are valuation, deadlock and retirement. Most often, owners put together buy-sell agreements that address the easy triggering events, death and disability, and carry on with a false sense of security that “all bases are covered.”
Owners that have the energy to have buy-sell agreements drafted often tell the drafting lawyer to “keep it simple.” They say that out of a desire to keep fees at a minimum or are unwilling to tackle difficult issues with their partners. Agreements provide a method for determining the value of the departing owner’s interest and how the purchase price will be paid. So, when they are asked how company value should be determined, they will often say “let our CPA figure that out when the time comes.”
Many lawyers concede and draft a provision that has the CPA determine the value of the departing owner’s interest. Is that fair? If the CPA will no longer have a relationship with the departing owner, will the valuation favor the purchaser who runs the company the CPA will continue to work for? Alternatively, many agreements provide the “book value” (assets minus liabilities) is the value to be used. That method does not give effect to goodwill – the intrinsic value built over time by a business given its reputation, customer list and other valuable items such as intellectual property.
Determining the value of a company and the ownership interest being transferred is an art that should be left to valuation experts. Therefore, buy-sell agreements should provide that an outside valuation expert selected by both sides of the transaction should determine value of the shares to be transferred.
Businesses often fail because the co-owners cannot agree on critical, major business issues. Unfortunately, many owners spend a great deal of time and wealth litigating deadlock, since that triggering event is often too difficult to discuss and usually not addressed up front. Bickering owners often run to the company bylaws or buy-sell agreement to see what relief mechanisms are in place, but are likely to find nothing is in place to help.
What if a buy-sell agreement contained a mechanism to address deadlock? Although it is difficult to discuss “divorce” up front, agreements can have a selection process that forces one of the owners to put a price “on the table” at which he or she would be willing to buy others’ ownership interests or sell what the owner possesses. This provision forces the selected owner to put a fair price on the table and provides an avenue for owners to part ways in an orderly fashion.
Owners are extremely busy making their business work. They need to find customers, develop dependable revenue and nurture a talented workforce to deliver the company’s product or service. Usually, retirement is the last thing owners want to think about – it is something that happens later and “we’ll figure it out then.” Owners are well-served to document what happens when they want to retire. Experienced attorneys and CPAs can help craft provisions that have worked well for other clients.
Buy-sell agreements often come up short in critical areas. Spending the extra time, money and energy to craft provisions for extraordinary events is critical in helping owners get along and preserve what they have built together.
Michael C. Foltz, JD, CPA, CFP® is a BDF founding principal and founder of our Business Owner Team with an extensive background in law, tax and estate planning. Mike shares his deep estate planning expertise by following the ever-changing federal and state estate tax laws and preparing education summaries for clients and team members. Recognized by Chicago magazine as a Five Star Wealth Manager, Mike has given numerous presentations on estate planning to BDF clients and professional organizations such as the Exit Planning Institute. Publications such as Inc. magazine and the Wall Street Journal have featured his insights into estate planning, and he has contributed to an estate-planning publication for Commerce Clearing House.