A contractual agreement between business partners
There are several reasons why a business should have a buy sell agreement. A buy sell agreement governs what happens in certain situations when a company is owned jointly with others, such as:
- Disability
- Death of an owner
- An owner who wants to dispose of their ownership interest
- Retirement
- Divorce
- Termination of employment
- Loss of a professional license
- Bankruptcy
- Third-party offer to purchase the business
Essentially, the corporation, business partners, or shareholders agree to the terms and conditions of a future mandatory or optional sale upon the occurrence of a triggering event. Working with an experienced CPA will help ensure all the financial details of the agreement are prepared correctly.
- Buy Sell Agreements Should Be Developed Sooner Rather Than Later. Smith Schafer is frequently asked to help with buy sell agreements at the time of an event, but it is much easier to get an agreement in place when everyone agrees.
- Include Valuation Language. Business owners may think it is more efficient and proactive to include a stated formula in the buy sell agreement to determine the value of the business when an event occurs. In reality, having a stated formula may restrict how incidents are handled and negatively impact the owners. Smith Schafer believes the best way to handle valuation-related items in a buy sell agreement is to either have language:
- at the time of an event, a valuation expert will be consulted (including a description of who is responsible for payment to the expert), or
- a valuation will be prepared annually by an expert. The buy sell agreement would be updated periodically with either the most recent value or a description of the method to use to estimate the value at the time of an event (within the next year). In this case, there should be additional language covering the situation if the annual valuation is not done, stating a valuation will be prepared if an event occurs.
- Understand Tax Implications. When developing a buy sell agreement, the owners should consider the tax and legal impacts of a buyout on the business and their situation and incorporate terms offering protection from unfavorable circumstances. There are specific ways a sale or buyback by the company can be structured to minimize taxes or pay overtime.
- Revisit the Buy Sell Agreement. Once a buy sell agreement is put into place, it is easy to feel comfortable that there is a plan, but as time goes by and the business evolves, the buy sell agreement may become outdated. When an event occurs, the language in the buy sell may no longer represent the owners. It may create stress and dishonoring if the partners believe they are being mistreated and decide to challenge the agreement (i.e., bring a lawsuit). Relative to valuation, a formula or process that was appropriate at the time of inception – or even subsequent revisions – of the buy sell agreement may not be applicable at the time of the event.
Need Help understanding Buy Sell Agreements?
A buy sell agreement serves to solve problems in advance of any potentially contentious times in the business. For further information on our business advisory services, please contact us at [email protected]. We can help assess your situation and determine the best way to proceed.
