By Maurie Cashman
More Reasons for a Well-Designed Buy-Sell Agreement: Part II
Business continuity agreements are extremely important to any ownership transition planning process. Last week, we began a discussion of the business continuity agreement and how this document can be one of the most important items that you will sign. We also detailed some of advantages of a business continuity agreement (also called a buy-sell agreement) when establishing transfer of ownership, valuation designs, and terms and conditions.
Now let’s look at how these agreements can protect rights among shareholders, provide a means for joint owners to come to agreement regarding the future of the business, and establish a market for stock at a pre-determined price.
Buy-sell agreements establish and protect rights among shareholders.
Through a buy-sell agreement, a minority shareholder may attain more control over his or her destiny than is normally provided through voting rights. A buy-sell agreement may place limits on the sale or purchase of the stock of the majority owner(s), establish valuation of all owners’ stock, give minority owners the right to sell their stock if certain events occur, and other important items.
An example of the type of right that a buy-sell agreement can establish is to provide the owner of a minority interest the right to serve on the board of directors. This can be an important right because a minority shareholder might not otherwise be able to acquire enough votes to be elected to the board.
A second example is requiring the corporation and remaining shareholders to make their best efforts to release a departing shareholder from any personally guaranteed indebtedness, as well as to release any personal collateral used for corporate debt when the owner of that collateral sells his or her interest in the company.
Recall Joe Mower from the hypothetical case study we discussed last week. As a minority owner, he was unable to buy control of the company and was unable to prevent a new majority owner from exercising total control over the company. A buy-sell agreement could have prevented that.
An intangible benefit lies in the design of the buy-sell agreement.
“If you don’t make things happen, then things will happen to you.”
— Robert Collier
Often when there are joint owners of a business, they do not sit down together to discuss business issues. In order to draft a buy-sell agreement, a meeting of all owners is essential. In these meetings, they address major questions affecting their relationship:
- What happens if the owners don’t get along?
- What happens if one wants to retire before the other?
- What happens if one of the owners dies?
Obtaining answers requires owners to discuss their ideas about the future of the business.
For example, let’s look at the hypothetical case study of Henry and Darci, both equal partners in a manufacturing business.
Henry and Darci had a poor relationship. They were certain each had opposing views on the future of the business in terms of both growth and their respective desires to remain in the business. They each also had their own ideas about their own importance to the business.
During meetings with their advisory team, they learned there were many reasons for their company’s success. Although one owner was the “money man” and the other was more active in the business, they learned that both were equally concerned with the future of the company. This recognition allowed them and their advisors to draft a buy-sell agreement for their mutual benefit.
The process took almost a year. During that time, the owners met periodically with their advisors to review business goals and aspirations. They found themselves increasingly in agreement, not just in matters contained in the buy-sell agreement, but also with respect to operational ideas. Those basic agreements soon broadened into consensus on how the business should proceed if one of them were no longer with it.
As a result, their business became more vibrant, focused and directed. The owners became more committed and the company’s profitability and value increased steadily.
A buy-sell agreement establishes a market for an owner’s stock at an agreed-upon price.
Without an agreement, there’s no market for stock in a closely held business, even if you’re a controlling owner. Most buyers want to own one hundred percent of a company and don’t want the potential baggage of a co-owner not of their choosing. Your ability to sell your interest will be limited unless you can require your co-owner to also sell. If you have not made firm arrangements for the sale of your stock, the buy-sell agreement is the only means of disposing of your ownership interest at a fair price. The agreement can obligate the other owners to purchase your stock, thus creating a market if you must sell your stock due to events such as death or disability.
There are several important variations and provisions that can be included in a buy-sell or ownership continuity agreement. These provisions can be tailored to protect majority or minority shareholders, or hopefully both and to treat each party fairly. An honest and thorough discussion of the needs of the business and the owners can remove uncertainty, misunderstandings and be a catalyst to aligning ownership to increase the performance of the business. As should now be evident, there are many advantages to a buy-sell agreement.
© 2016 Aspen Grove Investments, Inc.