When coming up with the terms for a buy-sell agreement here are the top four issues you need to address:
1. What Are the Buyout Triggers?
A buyout trigger is exactly what it sounds like, the event that triggers the buy-sell agreement. A few of the most common triggers are death, divorce, retirement, and disability. Not all of these triggers need to be included in your buy-sell agreement, so make sure you choose what works for your situation. If a certain owner wishes to pass on his shares to his family for example, you wouldn't necessarily want to trigger the agreement in the event of his death.
2. Who Will the Buyer Be?
It's not enough that you choose a buyer, you need to choose the right buyer. If a certain shareholder performs a duty that no one else in the business is capable of, you need to make sure the buyer is also capable of performing these duties. Likewise you should make sure any potential buyer is capable of running the business competently.
3. What Is the Purchase Price?
When it comes to money the conversation can often get heated. Buy-sell agreements contain something called a valuation provision, the clause that establishes the price of buying the departing owner's interest in the business. The best and most accurate way of determining a purchase price is with an independent appraisal performed before the interest is transferred.
Other methods include negotiations, which work well if all parties are generally agreeable, and valuation formulas. Valuation formulas are quick and easy, but don't take into account the subtleties of certain industries or the changes in a company's value over time. Whatever method you choose, be sure it is all clearly defined in your buy-sell agreement.
4. How Will the Purchase Be Funded?
There are a few ways to fund buy-sell agreements, each with their own advantages and disadvantages. The most common funding methods are:
- Life Insurance. Funding the agreement with life insurance has the advantage of being the least costly method and the cash will be there right when you need it, but if your business increases in value you will have to purchase additional insurance. Getting good rates also assumes that the person you are taking the policy out on is healthy which is not always the case.
- Business Loan. Borrowing is simple and it doesn't require you to spend any money until the funds are actually needed. On the other hand it can be difficult to get a loan if your business has just lost an important asset.
- Sinking Fund. Cash is simple and doesn't come with any strings attached. The one downside is that depending on the methodology you use to determine the purchase price, you may not know exactly how much you need to save.
At Summerlin-Roberts we will work closely with you to draft a buy-sell agreement that meets the needs of your business. Please contact us at Summerlin-Roberts today for more information on buy-sell agreements and why your business needs one.