Most business owners put a lot of time and effort into their businesses. In many cases they would like to leave the business to their family, or at the very least, ultimately sell the business for a future value. However, life events can interfere with their wishes. Because of this, it is important that the owner has a buy and sell agreement which will smoothly transfer the business to the heirs, but will also help establish future provisions for the family, should they retain the business.
The solo owner can engage into a buy and sell agreement (Called ONE-WAY BUY AND SELL (BSA), or, UNILATERAL BUY AND SELL) with:
- Their children
- A trust
- A competitor
- Employee or employee group
- Others who may be interested in the business
The reason for the BSA is to provide liquidity to family, and to have an orderly transfer of the business.
Leaving the business to:
Children: Not all children are capable of running a business. In some situations, the inheriting children do not have the experience, the want, or the ability to run the business. Even if they inherit the business and decide to sell it, they will be at the mercy of the market whims at that time. Competitors will try to buy the business for pennies on the dollar.
Spouse: The issues apply as above. However, in many cases, the spouse is trying to replace the income of the owner. There may be a sense of motivation to sell the business for the security of cash.
Competition: This will allow the family to receive the business value based on the agreed price in the agreement.
Of course, if the family members are very active in the business and want to run the business, a buy and sell agreement can be set up so the children will buy the business for a stipulated price. The spouse will receive the value of the business This can be done by funding with life insurance, or through the cash flow of the business.
There may be situations which not all of the children want to be in the business. If that is the case, testamentary provisions can be made to equal out distribution of assets if that is a concern.
Spelling out. What is important is that all parties understand the nature of the buy and sell and what is expected. For example, there could be a situation which all the children buy the interest, however only one of the children is the experienced employee. The other children owners have very little experience. While the unexperienced children have a job, salary, they don’t really share in the responsibilities of running the business. There should be defined instructions as to the role in the business for inheriting children and compensation levels as a guide.
Some of the challenges when children buy the business:
- Who will be in control of the business?
- Shifting loyalties can change the dynamic of the business and the direction it will be guided among stockholder’s/interest holders. What are the provisions concerning selling to others?
- Are there restrictions on selling the business interest to outsiders?
- What if a sibling wishes to sell to another sibling? What is the price and how will it be determined? What are the terms?
- What level of value will the transaction be priced?
- What are the rights of transfer to the other siblings or outsiders?
What should be considered in a One Way Buy and Sell?
- May require that any subsequent owners of all or a portion of the shares agree to be subject to the agreement.
- If the interest is left to a trust, it can be required that any distributions from the trust require the new owners to be subject to the agreement.
- For future value of the interest, the current owner can set in motion a single-valuation method annually to create a value trend. It should state in the agreement that the value of the interest be done by a single appraiser annually, or a set schedule such as bi-annually. Consequently, by having a valuation schedule this reduces the change of valuation arguments.
- Restrictions on ability to transfer shares to outsiders; limitations or giving the remaining interest holders the right of first refusal.
- Terms of any future transactions under the buy and sell agreement: This is the opportunity to stipulate the terms under which future transactions might occur.
- Trigger events other than death: Identification of trigger events other than death. (Such as quitting, firing, retirement, disability).
- Funding options: In not every situation will there be the funds to purchase a terminating owner, there should be a built in option for the company to help finance, or purchase the interest upon a triggering event. The BSA should address these issues
Who should be concerned about the buy and sell agreement for the single owner businesses
The owner: Without the buy-sell agreement the owner leaves the future status of the business up in the air for all the interested parties, causing confusion and disagreements.
The children or heirs of the owner: The family should want some certainty about the future ownership rather than uncertainty. Remember, the business has been the financial hub of the family, and may also be the future dependency. The agreement will give the family the guidance for the future.
Advisers to the owner: The owner’s advisors should have information about the agreement, and in some cases be involved with the structure. The CPA, attorney, insurance advisor, financial advisor and exit planning specialist, should be involved to some extent. Each of them will have a part to play for the best outcome.
Last thoughts! There are number of other reasons for the 100% owner to have a BSA, but the one standout reason is they probably have more experience in running the business than anyone. They have developed the relationships with clients, customers and vendors, which have supported the business over time. They have the instinct of doing what is needed for the success of the business long term. At their death, there will be an adjustment period vs for any new owner. By creating a smooth transition for the business through a BSA, it can be a calming experience for new owners, clients, vendors and future customers.
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