Creating a buy-sell agreement requires foresight about what could, might and will happen to the business if certain situations occur to the equity owner’s/stock holders of the company. This article looks at some of the important elements of the buy-sell agreement (BSA).
First of all, what is the purpose of the BSA? Simply, an agreement between, interest holders, and the corporation as to what will happen to the company and interest holders should there be a disruptive and harmful occurrence in the future. These are called triggers; death, disability, divorce, departure (voluntary and non-voluntary), bankruptcy, retirement, and others.
It is important that the agreement be entered into when parties are aligned and before triggers events occur. It usually is a time when the relationship is aligned for the good of the interest holders and the company. In short, they usually are of the same mindset that any of the triggering events could happen to them in the future,
This is a time where advisors should encourage interest owners to complete and sign the BSA, as it is the best time when their attitudes are in synch concerning future event happenings.
Interest owners know that when there is a trigger event, each party will have a different perspective as to outcomes for each person. Terms and pricing transactions can become difficult or impossible to achieve if the issue was dealt with without an agreement in advance.
Some of the characteristics required in the agreement;
- It should be in writing and signed by all parties. (good time to have spouses sign as to their witnessing and understanding of the agreements, although they are not signing as a party to the agreement)
- Trigger events should be defined and funding and price adjustment; Each event should be discussed as to what will happen as to the price, and the terms. Also, the definition of the trigger event should be in the agreement. Example: definition of disability? What happens if a person is fired? What happens if a person decides just to leave? What happens upon a divorce, or bankruptcy, retirement, or death?
- Determine the conditions that cause the triggering events.
- Determine the price (price per share) at the time of the triggering event.
- Methods of Valuation
- Fixed price; usually never updated with changing markets, and company condition.
- Formula: with all the variables of economic conditions, company conditions and market conditions, it is hard to find an accurate formula for any given company or industry.
- Single Annual appraisal (updated annually or bi annually); Suggest the initial pricing of the company by a single appraiser, and then update yearly or every other year.
- Define how the triggering event will be funded.
- Creating a buy-sell agreement takes future thinking by all the interest owners. There is always the “what if’s” of the future, but owners need to be aware of them and protect themselves.
The BSA is the most important document owners of a business can have. They must have one. Without it, there are no instructions as to what will happen, how much they will pay, and how to fund it. There ends up being chaos, arguing, and lawsuits, not to mention the costs of fighting in the courts.
(Some great resources: Buy-Sell Agreements for Closely Held and Family Business Owners by Z. Chris Mercer, and Buy and Sell Agreements, Paul Hood)