A Buy-Sell agreement (BSA) serves several key purposes for business owners. A well-articulated BSA creates a ready market and liquidity to a selling owner, and should establish price, terms, and financing for the transfer. In short it spells out a process so that all concerned know what to expect in the event a “trigger” event (e.g. death, departure, disability, etc.) should occur. Let’s look at some reasons why BSAs often fail.
The BSA contract is usually drafted by an attorney when the entity is formed. Even if well-written, it will generally lose relevance over time. Business and industry conditions change, the owners’ individual goals and circumstances change, or the language may leave too much room for interpretation, opening the door to shareholder disputes and litigation.
Buy-Sell Agreement by Type
There are three types of BSA’s: formula driven; fixed price; and valuation process. Boilerplate formulas and fixed prices may be less costly on the front-end, but could end up costing a bundle in business value, because they are simplistic, easier to manipulate, and less able to capture business economics. Business valuation is derived from economic conditions and business fundamentals. Of the three BSA types, only the valuation process provides the tools to assess business fundamentals throughout business cycles, product cycles, or industry changes.
Trigger Events and Uncertainty
I mentioned just a few trigger events above. The important thing to note is that a trigger can alter the personal objectives of one or more owners and impact the business. Either can have both control and valuation implications. Another area where conflicts arise is when the standard of value to be used isn’t made clear. For example, the difference between investment value and fair market value can be very large. A buyer would prefer a lower price typical of fair market value, while the seller would favor a higher price offered by investment value. Similarly, the level of value can create potential for conflict if not clearly addressed in the BSA, because the difference between a controlling interest and a minority interest can be substantial.
Unfortunately, the Buy-Sell agreement is often overlooked and left in the corporate dustbin. As should now be more apparent, this is a vital document to keep current and help owners achieve consensus before confusion and conflicts arise. The ultimate goal of a BSA is to enable orderly, efficient share transfers, minimize confusion, and avoid litigation that can create a lose-lose situation for the business and its shareholders.
Jerry Matecun helps business owners to discover key planning and investment considerations vital to build and protect the value of your business and personal assets. For a no cost, confidential conversation regarding your business valuation and exit plans call or email Jerry at 949-273-4200, 616-499-2000 or firstname.lastname@example.org.