This is the time of year when many business owners are planning for the new year, evaluating last year’s performance and goal setting. Many will prepare a budget or business plan, review their year-end financial statements, and maybe have their statements audited for reviewed and have their tax returns prepared.
We recommend that same mindset be applied to revisiting your business organizational structure and corporate governance. This includes bylaws, operating agreements, employment, and buy-sell agreements. These agreements may not have been updated since the formation of the business.
This can be best accomplished as a team effort of advisers to include the attorney, banker, insurance agent, and CPA who focuses on the financial aspects of governance and succession or owner transition planning.
Owner transitions are crucial events for a privately-held business and the families of the owners. Buy-sell agreements are important to ensure the owners and their families are treated fairly and reasonably as a result of an owner transition. There are endless options to structure owner transitions and related buy-sell agreements.
In his book, Buy-Sell Agreements for Closely Held and Family Business Owners, Chris Mercer identifies commonly used buy-sell agreements:
- Valuation agreements — The business value is determined by one or multiple valuation appraisers. The buy-sell agreement defines key aspects of the valuation process such as the standard of value, level of value, application of discounts for lack of marketability and control, et cetera.
- Fixed-price agreements — Owners agree on a fixed price for the business value. Price remains static over time which may or may not represent a fair and reasonable price depending on changes in the business, industry, and economic environment.
- Formula agreements — A formula agreed upon by the owners will determine the business value typically based on financial metrics (e.g. stated multiple of earnings or book equity value). Similar to a fixed-price agreement, the formula may or may not result in a fair and reasonable price over time due to the changes in facts and circumstances of the business.
- Shotgun agreements — A triggering event results in an owner tendering a price to buy or sell an ownership interest in the business. The owner receiving the offer has the option to buy at the offered price or sell at the same price. A “fair and reasonable price” is anticipated as each owner could be the buyer or seller. However, the financial circumstances and personal employment status of each owner and their family can influence the offering price and related decisions or implications.
Each type of buy-sell agreement has many nuances, advantages, and disadvantages. The “right” type of buy-sell agreement often depends upon the circumstances of the business, owners, and the owner family dynamics.
Dean Dorton’s business advisory and valuation group has assisted many business owners with transitions and structuring their buy-sell agreements. Let us become part of your advisory team to review your business organizational and governance.