By Troy L. Harmon, CFA, CVA, | Director of Research, Henssler Financial
Starting a business is exciting. Thoughts of success often flood out the other potential outcomes. Even successful businesses, those with attractive profits and growing sales, can experience turbulence at times, especially when more than one partner is involved. People, even friends and family, seem to measure their output and income differently than their peers. Whether real or perceived, once an individual thinks they have been slighted, the drama begins. This can be the source of tension among business partners. While you might be thinking this would never happen to you and your friend/family member/business partner, in our experience this scenario is a very real concern.
Often, addressing the potential for a problem before it ever becomes a reality, can allow all involved parties the protection needed in a business relationship. In this case, we are referring to a buy-sell agreement drawn up at the business inception. With an agreement in place, it may allow friends and family to avoid the often ugly reality of business separation. The point of a buy-sell agreement is to provide a way for partners to separate or sell a business because of unforeseen differences, disputes, health issues, or retirement of one of the partners. It is good to think of these things before you get too far down the path to success. If you wait until there is a conflict, it often gets ugly very quickly. You might find yourselves unwilling to speak to your partner except through an intermediary, usually an attorney.
Buy-sell agreements can be customized to fit the involved partners. Some will provide for the business to be valued by a professional with the partners required to accept the resulting opinion of value. If that will be the case, make sure there is an agreement as to the professional’s qualifications. The Small Business Administration has a list of six valuation-focused designations they identify as qualified to provide a business valuation. These include: Accredited Senior Appraiser (ASA), a C.P.A. Accredited in Business Valuation (CPA ABV), Certified Valuation Analyst (CVA), Accredited Valuation Analyst (AVA), Certified Business Appraiser (CBA) and Accredited Business Certified Appraiser (ABCA)—any of which should be able to provide an opinion of value on a business.
Other aspects of buy-sell agreements can be a focus on the untimely death of a partner. While it may be uncomfortable to think of this possibility, life insurance policies on the life of each partner may be the easiest cure for this risk. Should one of the partners pass away, the life insurance policy could provide the remaining partners sufficient funding to pay out the deceased partner’s heirs. This should be reviewed periodically to ensure the policy amounts match the business value. Additionally, consider the effects that a future illness might have on the ability to purchase life insurance. If you or your partner were to be diagnosed with cancer in the future, you may not be able to find an insurer willing to write a life insurance policy, at least at a reasonable price.
Speaking of funding of the buy-sell agreement, businesses with multiple partners may find it beneficial to save for the eventual transactions to buy out partners. Retirement is a common reality that partnerships face. Being able to buy out a retiring partner without securing a loan is a benefit to the business. Knowing the value of the business and the terms of the buy-sell agreement is necessary in order to know the amount of funding needed.
Another concept is the forced sell or buyout of a partner. This is the more colorful version of buy-sell agreements, but it ensures that the partners involved separate and often provide for business continuity. However, these agreements do not dictate who might come out of the transaction as the owner. If one owner defaults on his or her duties to the business, files for bankruptcy, or the owners come to major disagreements in how the business should operate, often the partnership becomes contentious. In this instance, a buy-sell agreement might dictate that if one owner offers to buy out the other (assuming equal ownership), the offer to buy can also be considered an offer to sell. If the offering partner provides a low-ball bid, the partner receiving the low bid can buy the offering partner out for the same price. This type of agreement would still leave one of the partners in control and it also incentivizes both partners to make a fair offer in case of major disputes.
While this is not an exhaustive list of buy-sell considerations, you can see the business value is often the focal point in a business transaction. Making sure you have covered this possibility when times are good is very important in protecting your interest in the future. If you own a business without a buy-sell agreement in force, don’t wait until there is a problem, provide for a resolution to unforeseen future conflicts today. If you have questions, contact the Experts at Henssler Financial: