How would you like your business partner's ex-spouse to help run your company? Does it sound like fun to have a bank own part of your business should your co-founder file for personal bankruptcy?
Without a buy-sell agreement in place, business owners risk these scenarios and other situations that can disrupt the business and hurt its value. Having a formal agreement can define a desired exit strategy and ownership succession plans, providing a roadmap in the event of a death, divorce or disability, says Rachel Flaskey, a senior manager in the valuation services practice of Baker Tilly, a top 15 accounting and advisory firm in the U.S.
"Those are all circumstances that can be planned for somewhat," she says. "But you also have the unforeseen circumstances: an argument or the shareholders aren't clicking anymore. Or maybe you want to allow future owners into the business."
A buy-sell agreement allows entrepreneurs to know up front who can buy in to the business and how the process will work, and it provides opportunities to talk about possible scenarios rather than forcing owners into expensive litigation down the road.
"It's one form of a business continuity tool," Flaskey says.
Having a buy-sell agreement, however, is apparently not a high priority among many business owners. Nearly three out of four business owners lack documented succession plans (which can include buy-sell agreements) for senior roles. With the government estimating that nearly 52 percent of business owners are over the age of 50, that's a lot of companies with the potential to be thrown into chaos and lost value upon the death of an owner.
Here are six things business owners should know about buy-sell agreements, according to Baker Tilly's Flaskey:
- They should be developed early. The time to create a buy-sell agreement is well before it is needed. As Flaskey says, "It's a lot easier to get an agreement in place when everyone's in agreement." By the time circumstances warrant utilizing a buy-sell agreement, people could have other interests at play, making it more difficult to reach agreement on various items. And while it's really never too early in a business's life to develop a buy-sell agreement, keep in mind that business needs evolve as the business evolves and could warrant changes in certain agreement provisions over time.
Typically business owners involve a lawyer, their accountant and sometimes an outside valuation professional to walk through developing a buy-sell agreement. Flaskey says talking through what owners want to accomplish with the agreement is important. "Is it to avoid arguments, to maintain value, to provide an exit, to make sure that if somebody's not really involved in the business anymore they're not getting the benefits of other people's work?" she asks. "The purpose behind it drives some of these other factors."
For many businesses with $10 million or less in revenues, the market for selling the business is pretty small. Given the number of baby boomers nearing retirement, having a buy-sell agreement or other exit plan is really important, according to Flaskey. "If you get to retirement and you can't sell the business, what's going to happen to it? You either need to be grooming management or one of your kids, you need to be thinking about selling to a key employee or converting to an employee-owned company," she says. "There are a lot of business planning tools and a buy-sell agreement is just one of those."