Jay Sachetti joined Jeff O’Brien, partner at Husch Blackwell and Dyanne Ross-Hanson, president of Exit Planning Strategies talked about the market for mergers and acquisitions, exit planning opportunities for companies that don’t end up for sale and how companies can maximize their eventual sale price during an early October panel at the first Upsize on Tap event at Summit Brewing Co. in St. Paul.
When the state Legislature passed a law requiring employers to provide paid leave and safe time for employees, Justin Bieganek started hearing differing details from friends, colleagues and peers.
A BUY-SELL AGREEMENT should exist in every private company with multiple owners, including family businesses.
In fact, many professional advisers argue that it’s likely the single most important legal document an owner will sign.
Basically, it establishes the “exit rules” when a co-owner chooses — or is forced — to leave the business.
It is a legally binding contract between shareholders and/or partners (owners) of a business that restricts the transfer of their ownership interest to unintended parties.
A buy-sell agreement specifies who is allowed or required to buy the departing owner’s shares, which events will trigger a buyout and what price will be paid for the outgoing owner’s interest. It also provides for an orderly succession plan for the ownership and management of the business if an owner wants or needs out.
As important as buy-sell agreements are to the business’s continuity, they can simultaneously create more problems than they solve, if they are not drafted correctly or reviewed regularly.
(A note of disclosure seems appropriate here: While I’m not a licensed attorney, my work with business owners over the last 25 years has afforded me the privilege of reviewing numerous buy-sell agreements and consulting with numerous qualified business attorneys.)
Let’s presume your attorney has drafted your buy sell agreement, you and your business partner(s) have even signed the agreement and you have deftly “filed” it away in a dustproof drawer for safekeeping.
All is well, right?
Leave it to a “triggering event” to occur, and all interested parties (along with their legal counsel) now scour the document to reference its provisions. What could possibly go wrong? Below are some of the most common pitfalls.
Triggers are those events that initiate one party’s right or obligation to buy the stock of another party, under the agreement. The most common triggering events found in buy-sell agreements, are death or disability of an owner. What is often overlooked are the more likely “living” events that trigger ownership transfer.
These can include retirement, divorce, termination (voluntary or involuntary), declaration of insolvency, illegal act and, of course, disputes. Yes, the latter do occur. The more inclusive the triggering events, the less likelihood of misinterpretation, or worse yet, litigation.
Valuation can be a major source of contention in every buy-sell. One of the most troublesome provisions is tying the valuation to some agreement between owners to be made in the future or according to a schedule (i.e. annually). Owners may not be the best judge of value.
In addition, the agreed upon price is often not kept current. Formula valuations (i.e. book value) may not be tied to the reality of the business, as it grows. Valuation tied to an appraisal may be best, but careful consideration of who chooses the appraiser is important.
Buy-sell agreements should have “sell-by” dates, just like the groceries in our cupboards. When they lie at the bottom of dark drawers, collecting dust, unreviewed, they can yield some ugly surprises, when the light of day shines upon them. Changing business circumstances, owner objectives or worse yet, owner identities, can cause huge problems if not regularly reviewed and updated.
After agreeing upon whether the buyout shall be mandatory or optional, partial or full and even on how to value the interest, business owners still must address payment. How will the seller be paid? How might this affect the future viability of the business?
In the event of a death-triggering event, life insurance can offer an immediate, tax free receipt of cash, at precisely the time needed. Is it an option? Is it adequate? Does it last long enough? Is it properly structured? Care must be given to make sure the insurance benefit, policy owner, beneficiaries and premium payers are all properly aligned.
Accessibility and unintended tax consequences can result when the life insurance is not properly structured and reviewed.
Buy-sell agreements essentially take three forms. Redemption, where the entity purchases the interest. Cross-purchases, where one or more persons buy the entity interest. And hybrids, which mix the two.
When funded with life insurance, cost basis adjustment (or lack thereof), potential Alternative Minimum Tax (AMT) exposure on death proceeds, premium costs and the number of policies needed, are all impacted by the chosen design. Inexperienced owners and advisers, beware.
It is one thing to provide for sale of ownership interests and quite another to consider related property. Related property can include interests in affiliated entities, or interest in land or other property co-owned by some or all the remaining owners (such as property where the business operates), or life insurance policies on the life of a selling owner.
It can also include intellectual property, leases or other contractual rights or obligations. While the buy-sell agreement may/should not address all these issues, reference to them might offer a “fall back” if shareholders cannot negotiate an agreeable remedy.
Many times, business owners think seriously about buy-sell agreements only after they’ve already entered into other agreements that can impact the effectiveness of the buy-sell. Examples include articles of incorporation/organization or partnership agreement, bylaws/operating agreements, loans or security agreements, franchise agreements and leases. Buy-sell agreements must be coordinated with these other agreements.
Buy-sell agreements are designed to provide objective means of transferring ownership in controlled and pre-determined ways under specified circumstances that may be difficult.
In the absence of a workable agreement, the remaining shareholders and the corporation may be placed in the unenviable position of negotiating under adverse circumstances with former friends, their families, or their estates. Such negotiations, which would occur after the interests of the parties have diverged, are difficult, fraught with uncertainty, and often lead to litigation.
Review, update and revise your buy-sell agreements to avoid the potential pitfalls enumerated above.
