Insight
Buy-sell agreement - put it on your to-do list
March 2016
We often find businesses either don't have a buy-sell agreement, or where they do they haven't reviewed or updated it for some time. In this article we look at buy-sell agreements and why it is a good idea to have one.
Reviewing the basics
Buy-sell agreements generally apply to closely-held businesses. A buy-sell agreement (BSA) is a written agreement between the owners of a business that spells out what happens to each owner's share of the business in the event of another owner's death, incapacitation or some other unanticipated exit from the business. The BSA is an appropriate layer of protection for anyone who owns a business with other partners (family-related or not).
The best time to draw up a BSA is when all owners are healthy, on good terms and not contemplating leaving the business. In this way, everyone is in the same boat and will benefit equally from having a BSA in place.
There is no one-size-fits-all formula for a BSA. And there is no need to be overly predictive about the triggering events that might cause the BSA to kick in. You can't possibly foresee every scenario or account for every variable. Otherwise you may never get to the desired outcome of a reasonably complete BSA that is signed by all parties. So don't let a lack of specifics around triggering events hold you back from putting a BSA in place.
Valuing your business
Because your BSA will spell out how the departing owner's share will be bought and sold, it is important that your BSA specifies how you will value the business. There are several ways of valuing a business but they will mostly fall under the headings of fair market value or fair value.
Fair market value is designed to reflect the value of a business where a willing buyer and willing seller exist, with neither party being under any compulsion to buy or sell. Fair value reflects the value of a business where there is a forced sale.
The fine detail of each method and the names used to describe them may vary depending on jurisdiction.
Knowing which method to use
So which is the fairest method of valuation? It depends.
Fair market value may give an advantage to the buyer who is able to buy at a discount but leaves the seller (or the seller's beneficiaries) at a disadvantage. On the other hand, using fair value can mean the buyer is forced into buying at a premium when it doesn't suit; for example, the buyer already owns a controlling interest.
The most appropriate method of valuing your business will depend on its structure and circumstances. You may find you need a solution that sits somewhere between the two standard methods of valuation.
Professional advice - there's no alternative
Who can you turn to for help in drafting or updating a BSA? Since it is primarily a legal document, a lawyer well-acquainted with BSAs is an excellent starting point. But the ultimate litmus test for whether the agreement adequately protects your stake in the company will be to share an early draft with a certified valuation expert, and asking one simple question: if a triggering event were to occur, would you know what to do?