Why Use Non-Compete Agreements!

Non-compete agreements (NCA) represent a separate agreement. They could be in an employment contract, or as a separate article in a buy and sell agreement. Sometimes they are referred to as Covenants not to complete. “

This is based on the possibility that an employee can do harm to a company upon termination.  They could know sensitive information about the company’s operation, owners and employee’s personal information, special operations, and proprietary information to a competing advantage, along with so much more.

Picture a very long-term employee working side by side with the owners, for many years, and then leaving to work for the owner’s competitor.  Certainly, there can be issues.

No compete agreements (NCA), can be used to retain employees also.   It would be very difficult to change jobs within an industry or profession when the leaving employee is limited to compete in a geographic and specific industry for a period of time.  However, non-compete agreements are hard to enforce, because in many instances the agreement has overreached and is very broad in the definition of industry and geographic coverage.

Continue reading “Why Use Non-Compete Agreements!”

What Status Is The Stock After A Triggering Event?

Chris Mercer author of “Buy-Sell Agreements for Baby Boomers Business Owners” addresses a very good question.  Who owns the stock after the trigger event?  After a trigger event, does the affected shareholders retain the rights, risks and privileges of the ownership, things like, voting, distribution, access to financial information, etc., or are their shares converted to another status, such as (example), the “pending sales of stock” status?

If the shares are converted into the new class or status, do they have the right to receive dividends, or interest while in that pending status, if so, who should be receiving it?

The agreement can also have a clause where the stock that is waiting to be purchased would convert to a “non-voting “status prior to being purchased.

There are many times a stockholder has signed personally for a corporate debt.  The stockholder may desire to have the remaining stockholders make an effort to get the departing stockholder off the note, as they have ceased to be a stockholder.

The questions that Chris puts forth are legitimate issues and should be dealt with when business owners and their council set out to design a buy and sell agreement for the company.

Thank you, Chris Mercer, for bringing these topics to the forefront.

Over the years, many of the buy and sell agreements which I have reviewed over the years, do not address or mention these particular situations, and could create a void should the situation arise.

Check Chris Mercers publications.  He puts out very good information that is useful to practitioners.

Critical Questions That You Need To Answer If You Own A Business!

Building a business is hard work. Protecting and preserving it is even harder and overlooked by business owners.

While many owners expect family members to take over the business (69%), very few have actually made plans to make sure their wishes are accomplished (26%), even though they realize the importance of estate and succession planning as is an integrated part of that planning.[i]

A succession plan is complex, time consuming and involves attention to details along with many hard questions which need to be answered for a comprehensive and effective succession plan.  It is also the key element in maximizing the return on the investment of your business. This is the big financial payout, the sale of your business.[ii]

SOME MAJOR QUESTIONS AND ISSUES TO ASK YOURSELF!

What if a shareholder wants to sell their interests?

  • Is there a right of refusal for the other owners?
  • What are the financing arrangements?
  • What are the recourses if you fund the buyout especially if the funding is over a long period of time?
  • What is the arrangement if the business fails, how will you get your money if you financed the sale?

 Who steps in your shoes if you want out? 

Not everyone has the luxury of leaving a business when and how they want to.  Things like death, disability, and situations are uncontrollable.

  • What are your contingency plans when a trigger occurs (death, health, non-voluntary situations)?
  • Do other members of the firm have access and authorization to use funds to keep the business going if there is such an event?
  • Does your family take on personal obligations for financial notes and loans you have signed personally to fund your business operation?
  • Do you have estate documents and health care directives, should you have a disability or become incapacitated?

Taxes- and the planning for them Continue reading “Critical Questions That You Need To Answer If You Own A Business!”

The Story! The Cost of Funding Your Buy and Sell Agreement! Options!

The Story! 

The Cost of Funding Your Buy and Sell Agreement! Options!

Over many years I have experienced many business owners in total denial about the cost of funding their buy and sell agreements, thinking they can come up with the liability when the trigger of death occurs.

The four listed ways are compared below.

  1. Cash
  2. Borrow
  3. Sinking Fund
  4. Life Insurance

Let’s take the one by one.

Cash: This is assuming the company has the cash at hand, idle. Rarely is this an option. Growing companies reinvest in their company and only keep enough cash reserve as needed.

Borrow: A company just lost a valuable member of the company. Most bankers would probably want to see how the company will fair after the death of a key person and would want to know how the liability which has just been created will affect the cash flow of the company before loaning more money. There probably is a good chance that outstanding line be pulled in by the bank (probably a covenant in the loan agreement).

Sinking Fund: Mostly just theory! In 48 years, I have never seen a company try to develop a sinking fund. If the company was putting money in the sinking fun, they are losing the opportunities this money could create by investing in the business rather than on the sidelines. Not reasonable as the actual amount of money needed is available should death occur prior to the target date of accumulation. The least appropriate method.

Life Insurance: At its simplest benefits, it is immediate, tax free and the funding level is immediately known. Also, the cost is only 17 cents on a dollar rather than the much higher costs of the other three options.

Summary: While we don’t know when a death or disabilitymay occur, the company should at least be prepared for this trigger. Today the price of life insurance is low-cost. There is no reason not to purchase at least temporary life insurance (10-30 years), such as term insurance. The cost of life insurance in the example is using cash value life insurance.  Increased Sales To Fund Cost: Another measure of effectiveness of funding the buy and sell is to measure how much more in sales the company has to do to pay for the funding method.

Costs:  Funding over 15 years. 

Cash; 1,039,464 Loan: 1,306,085. Sinking Fund: 901,613 Life Insurance:  171,512

Also, what do you need to have in sales to pay for the method: 

Example, with Life Insurance Cost, @20% profit, sales would be $857,560

With Cash: There would have to be $5,197,320

 

 

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Disadvantages Of The Buy And Sell Agreement! [i]

Certainly, having a Buy and Sell Agreement (BSA) has many advantages, many of which I have discussed in our past posts (May 2019, Advantages of Buy and Sell Agreements).  However, I would like to go over the disadvantages of a BSA.

RESTRICTIONS ON ESTATE PLANNING

BSA can restrict ownership transfers and consequently management duties. These restrictions can be applied to you also. The restrictions could limit your personal planning by limiting your options for the ownership interests during your lifetime or at death. It may prohibit you from making gifts of your ownership interest to your family. Depending on your planning, your BSA could limit your plans to leave ownership interest to your family. The BSA may require your ownership interest to be sold at your death.

RESTRICTIONS ON FINANCIAL PLANNING 

A BSA can restrict the persons to whom you could sell your ownership interest to and restrict when you can sell it.  An example would be in a situation that you need to sell your interest because you’re in a financial bind. The BSA may require you to sell to your entity or your co-owners, who may not want to buy.

Special election to the defer federal state tax of deceased owners

This could limit an estate owner from using Code Section 6166 which is a way of paying your estate tax over a period of time, giving you the option of paying over a 15-year period, five years of deferral and a ten-year payout.  A purchase from your estate could cause the loss of the right to defer the estate taxes.

A sale of Corporate interests may result in a loss of the entities corporate structure

This could limit the entities right to use its own loss carry back and carry forward losses on a significant change in ownership, which is possible without a well throughout BSA.

The cost of putting together a BSA

It takes time and money to put together a solid buy and sell agreement, Of course this is a disadvantage and it can be expensive, however, in order to have an optimal BSA, you will need to invest time and money.  You will also need a competent council to prepare the necessary documents.  This incurs costs.  Being educated in this strategy is to your advantage when designing your BSA.

A poorly drafted buy sell agreement can be costly:  By failing to carefully work out the terms of buy-sell agreement or by having mismatches between triggering events and the identity of the purchaser versus the funding source, a real mess could be created.

[i] Buy -Sell Agreements for Baby Boomer Business Owners Z. Christopher Mercer, ASA, CFA, ABAR

Be An All-Star Employer and Build Future Value In Your Business!

When you go into your own business, do you have a place to go, a paycheck, and a position?  You basically have a job.   However, when entrepreneurs go into business, they look for the big payday, the selling of their business.    Would it be nice to sell your business for 10 or 20 times your annual salary?

Building a business is not easy.  If you are going to put your efforts into building a business, build a business with a great foundation.  It is easier to build value in a business with a good foundation.  Let’s assume you have systems in place and a business presence.  What is needed for real growth once you get through the systems and organization formats, is to create and develop a business culture!

By having a business culture, marketing and recruiting get easier and less expensive as people are more attracted to your company.  Long –term employees get to know the business, your customers you’re your suppliers.  They become more efficient and become the “team”.   You will attract better quality candidates to hire.  You can become more selective and create the right roles for your employees.

Go to Trader Joe’s and ask the employees how they like working there.  You will soon find out that there is little stress, a lot of fun, and the employees want to be there working side by side with each other.

When employees are happy and like their jobs, they stay, they learn, and they attract investors and future purchasers.  This culture promotes profitability and consistency, which is how you maximize your potential profitability of the company.  Consumers like consistency and the added value of having a company that is easy to work with.  I like to call this the “Amazon Factor”.  Who doesn’t like ordering from Amazon? They make it easy for many reasons.

Having this type of environment doesn’t automatically happen.  You need to invest in it to create it, however, it will pay off in the future.  They key is to start early creating the vision you have for your company long-term. Create the vision of being the “All-Star Employer”, and you will attract the best, like minded employees, and create a great business that people will want to work at.

 

The Final Act! The Day Will Come! Part 2

In part-one of this article, I mentioned how purchasers will prefer to buy a business where everything looks good and there are no apparent problems. Smart and neat operations will attract serious buyers; however, this is only one part that is needed to achieve your selling objectives.

There should be no hidden problems or secrets which can jeopardize the purchase. Any undesirable factor not disclosed to the purchaser can lead to a non-sale, or at the very least, something they can use as a negotiating tool. The fact that a deal has fallen apart, is not only frustrating, but will cost you money, time, and distraction from your business.

An owner who unknowingly discloses secrets or situations in their business can end up becoming a deal breaker. Issues which are known need to be dealt with to have the best chance of a good sale. Since there may be issues which are unknown the best answer to this is to search for the problems in advance and take care of them. Think of this the same way you would treat the sale of your home. You would normally fix up, repaint, and clean up before you put the home on the market. You should do the same thing with your business.

Not only would you want your physical location to be clean and tidy, but this also flows over to the other parts of your business, such as accounting, financing, marketing material, department procedure manuals, and an array of other business items. Prepared written policies and procedures are a great selling point for a prospective buyer. Remember, when someone is interested in your business, it’s their team that inspects every aspect of your business in doing their due diligence. This is a micro inspection of all aspects of your business, so it will pay to make sure there isn’t a bunch of dirty secrets hanging around.

FIRST IMPRESSIONS AND PHYSICAL APPEAL
The first time a prospective buyer visits your company they make value judgements. They will observe everything from your reception area to your signage in and on the building. If the impression they get is positive, they will want to investigate your company more. You don’t want to lose their interest based on visual appeal of your business. No matter how good your business seems to do on paper, the prospective buyer may lose interest based on your first impressions.

This observation doesn’t end with just the building. Your premises, marketing literature, dress attire of you employees, uniforms, office settings, rubbish areas and a host of other areas should be updated and tidy. Continue reading “The Final Act! The Day Will Come! Part 2”