Buy & Sell Agreements

The business owners should visit with an experienced attorney to discuss a buy–sell agreement. Once they have decided on the entity purchase format, the attorney will draw up the agreement. The parties to the buy–sell agreement are the individual business owners and the business entity. In designing the agreement, several
important issues are involved: buy–out events, valuation, funding, and buy–sell variations.

Valuation can be based on a formula detailed in the agreement, such as a percentage of sales.

• The agreement can require the parties to revalue the business every year. If the parties don’t revalue the business within a given amount of time, the agreement can provide a valuation formula.

• The agreement can require a professional business appraiser to value the business. The appraiser can develop a valuation based on several factors, such as the annual earnings of the business.

• The agreement can specify that value is determined by multiplying earnings by a capitalization factor, typically obtained by analyzing price earnings ratio of comparable businesses in the same industry.

Nearly all buy–sell agreements provide that the death or retirement of an owner triggers a buyout. The parties sometimes overlook the possibility of the disability or divorce of an owner. In the event of divorce, for example, the stock could end up in the hands of the ex–spouse, which the remaining owners may not want. Other triggering events can be the firing of a minority owner or the personal bankruptcy of an owner.

There are a few different funding approaches that can work here. One approach is that the company can simply create a sinking fund using a savings account or another conservative investment. The risk is that there may not be enough cash to fund the buyout or it might be unavailable.

Additionally, the company can borrow the money from a bank, but there will be interest costs. The bank also may be reluctant to lend money to a business if a key person has died or is leaving the company.  Assuming the agreement allows it, the company can also make installment payments.

There are a variety of other strategies and approaches to this issue, and this is just the tip of the iceberg.  Contact our team for a strategy discussion today!