Buy-Sell Agreements

Buy-Sell Agreements. For a free no-obligation consultation about a specific case contact Equity Strategies Group , an advisory firm serving private business owners and their advisors exclusively. (ESG is an affiliate of SPARDATA.)

A buy-sell agreement details how ownership in a business transfers if an owner dies, retires, or becomes disabled. It also addresses what happens if an owner divorces or wishes to sell his or her interest in the business. Having a solid buy-sell agreement—one that is up-to-date, properly funded, and based on an expert appraisal—can help avoid stress, hardship, and financial problems if something happens to an owner. Here’s why.

A buy-sell agreement always involves a seller and a buyer. When executed properly, it protects both parties. A good buy-sell agreement limits whom the business can be sold to, so that remaining co-owners are not stuck with an unsuitable new owner. It also ensures that sellers or their beneficiaries get a fair price for their interests. And equally important, it ensures that buyers pay a fair price for those interests.

Base Buy-Sells on Appraisals

People forget to update their buy-sell agreements. And often buy-sells don’t rest on an appraisal of the current value of the business. That’s a recipe for disaster, as shown in the following scenario, which is based on dozens of real-life cases.

Years ago two friends started a construction company. At their lawyer’s suggestion they signed a buy-sell agreement. The buyout price was set relatively arbitrarily at $50,000. (Some buy-sell agreements use a dollar amount and some use a formula, but the best approach is for the agreement to require periodic valuation by an experienced appraiser.)

The business grew and prospered. Before long, each owner’s annual salary was $300,000. Even though the value of the business kept rising, the buy-sell agreement’s exercise price was never updated. In fact, the owners didn’t think about the buy-sell agreement much at all, until the day one of the owners had a sudden, massive heart attack and died at his desk.

The remaining owner cut a $50,000 check for the deceased owner’s wife. She was incredulous. “Is that IT? This is all I get for half of this business? I’m calling my lawyer!” For the next two years, when the surviving owner should have been focused 100% on preserving and growing the business, he spent half his time in court.

Buy-Sells Avoid Problems

It’s easy to avoid ugly scenarios like this. Make sure that your buy-sell agreement specifies an actual purchase price determined by an objective business appraisal, and have the purchase price updated every three years (or more often if the business’ results warrant.) You should also see that your buy-sell agreement includes a mechanism for providing the funds needed to carry out the purchase. Although there are many funding options, one of the most popular is insurance on the owner’s life because it helps ensure that beneficiaries receive the agreed-upon price for the business.

The average owner spends 60 hours a week or more to build a successful business. Planning ahead helps ensure that those hours aren’t wasted. A buy-sell agreement offers financial protection and eases the transition when a business partner dies or exits the business. Make sure your buy-sell agreement is based on an expert appraisal of your company’s worth. Owners often think they know their company’s value, but in reality they may be shockingly misinformed. For example, SPARDATA, a leading national business appraisal firm, surveyed 2,000 business owners in 2001 and found that most misjudged the value of their businesses by 50% or more—sometimes by millions of dollars.