The Business Will
It is Not Just About Having a Buy-Sell Agreement
A business is a dynamic entity. Businesses are fueled by the passion and vision of its owners. While it is hard to be passionate about administrative aspects of building a successful business, the truth is, some of that stuff is crucial. Take the buy-sell agreement or similar provisions in an operating agreement—think of it as the business will—the “what happens if” document. And while all situations cannot be covered, the major ones—job performance, disability, divorce, retirement, and death—can. These provisions should be on the must-do list when forming or getting into a new business arrangement.
[su_pullquote align=”right”]Resources:
Buy Sell Agreements—The Business Will (or Won’t)
Transition Planning: The Good, The Bad, and The Ugly
Pre-Sale Planning—Opportunities and Valuation Challenges
Intermediate Business Valuation Training Center
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So, it happened again. I received a call today—caller asked if I could value their business. “Of course,” I said, “but let’s slow down a bit. Why do you think you need to have your business valued?” I queried. He responded, “… my lawyer told me I needed it so we can force my partner to buy me out. We don’t get along as well as we used to,” he said with a bit of sadness in his voice. And then he proceeded to explain how their relationship took a wrong turn and the business had suffered.
Even if partners retain the same vision for their business, unexpected events, like disability, can put a strain on the relationship and the business. How long should a disabled partner be able to share profits if he or she is not working? Sometimes the trigger is not the result of unexpected events, but merely the passage of time. How will you handle your partner’s retirement or divorce? Often these common situations end with a damaged business and a damaged friendship, or, if your partner is a relative, a family feud. However, a little foresight and planning can greatly improve the chances of a more favorable outcome.
A business is a dynamic entity fueled by the passion and vision of its owners. While it is hard to be passionate about administrative aspects of building a successful business, the truth is, some of that stuff is crucial. Take the buy-sell agreement or similar provisions in an operating agreement—think of it as the business will—the “what happens if” document. And while all situations cannot be covered, the major ones—job performance, disability, divorce, retirement, and death—can. These provisions should be on the must-do list when forming or getting into a new business arrangement. It can prevent, or at least minimize, distractions from productive business opportunities and allow you to remain focused on making money.
Convincing your clients or potential clients that developing such plans for a variety of eventualities is important; however, that is just the beginning. Chris Mercer, among others, have written volumes on the valuation elements to be referenced in buy-sell agreements topic. Mostly, we hear about the times the agreements just do not work the way they were intended to work.
Take a recent case, whereby the agreement called for annual updates and agreement of value by all the partners.[1] A common story: the partners did not update the value and the founding member who planned on retiring was forced to play, in part, by the rules he agreed to many moons before. In addition, matters were complicated by the somewhat ambiguous language regarding the setting of the price. Needless to say, time and money were invested in a process that, in theory, could have been avoided. I have clients who have “signed up” for the recommended approach of “one appraiser, appraise now” only to have my calls go unanswered when it is time for an update; and even worse, talking with the owners who forgo the update because the business is doing well and their (the partners’) relationship has never been better … that is until it is not!
Let’s get back to basics. From a valuation and pricing perspective, the key elements that all buy-sell agreements (or provisions) should have include:[2]
- Standard of Value
- Level of Value
- “As of’ Date
- Appraiser Qualifications
- Appraisal Standards
- Funding Mechanism
Standard of Value. Us appraisers know what this is; however, for the most part, it is “Greek” to everyone else. Including a definition from a recognized source goes a long way to minimizing any debate here. Leave it out and find out what happens.
Level of Value. Perhaps even more esoteric to those unaware (including many lawyers who draft these agreements) of the impact of using a lack of control discount is defining this element. Leave this one out and watch blood pressure and fees rise.
“As of” Date. Seems simple, right? Should the actual trigger date be used, most recent month, or quarter end? What about trailing twelve months? Most recent fiscal year-end? Depending on where a partner sits and where the business is in its life cycle can potentially change one’s perspective. Do not mention it in the agreement and watch the fireworks begin.
Appraiser Qualifications. The company’s CPA is in the best position to value the company, right? Well, maybe—how many appraisals do they do each year? Any in that industry? Was the CPA brought in by one of the partners? Who will look out for the company’s best interest? At the end of the day, key here is to make sure whomever does the valuation/pricing work has been trained to do the work, and understands all the nuances. I have even seen firms named here (as long as they have certified professionals on staff); if that is the case, it is always good to have an alternative—if not in name, then one who is certified can get the call.
Appraisal Standards. This rides on the tail of the Appraiser’s Qualifications. Simple enough, the appraiser who completes the work should follow the appropriate standards based on their certification.
Funding Mechanism. Just as important as the price determination, is how the transfer will be financed. The goal is ensuring the company, or the paying party, can actually afford to make the payments without putting the whole transfer transaction at risk.
There are some other adjustments to be considered that may lead to disagreement if not handled up front. For example, how should key person insurance cash value and proceeds be handled?
If these elements are discussed up front and during the drafting or revising of a buy-sell agreement, it may at least reduce the number of points in contention when that day that was never supposed to happen just happened. I recommend and try to work through the appraisal before the agreement is finalized or revised so any issues that come up during the appraisal process can be discussed and agreed to when everyone’s goals are aligned—document the process and get the agreement in place.
Perhaps next time I will share some samples of real agreements I have seen and helped revise. Or in some cases, end up in court where no one really wins.
Steven M. Egna, ASA, CBA, CVA, ABAR, CM&AA, is Senior Advisor at Valuation Resource Group, LLC, an East Greenbush, New York valuation, litigation support, transition planning, and M&A Advisory Services firm. Mr. Egna has over 30 years of diversified financial leadership and management experience specializing in transition planning and valuation analysis of all sorts. He brings a practical, hands on approach to all of his work.
Mr. Egna can be contacted at (518) 479-1008 or by e-mail to segna@valuationresource.com
[1] See Namerow v. PediatriCare Associates, LLC, 2018 N.J. Super Unpub. LEXIS 2633 (November 29, 2018).
[2] Mercer, Z. Christopher, Buy-Sell Agreements for Closely Held and Family Business Owners, (August 2010), Chapter 14.
