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Every small or medium-sized business needs a Buy/Sell Agreement. They outline what will happen if there is an unexpected event - like one of the shareholders dies or has to leave the business for serious health reasons. Like a will, the agreement can give the parties to it peace of mind and help promote financial wellbeing.

A Buy/Sell Agreement can:

  • Help other shareholders buy out a partner;
  • Pay down the business’ debts;
  • Cover the costs of another employee while a business owner is having medical treatment; and
  • Make sure the business has a seamless succession process.

Many businesses also take out insurance to cover these events. Along with a well-structured agreement, these can deliver certainty and help future-proof your business.

There are 5 things you should consider when setting up a Buy/Sell Agreement.

#1. Does it allow the business to grow?

As your business grows, you may want some key performers to become business owners. A well-drafted agreement will allow for this. If your Buy/Sell agreement doesn’t contemplate adding new business owners or you don’t have an agreement in place, your options are:

  • Deed of Accession: If you’re drafting a new Buy/Sell Agreement, we recommend including a Deed of Accession. This makes sure that anyone who is added to the Buy/Sell Agreement automatically agrees to its terms. So, you don’t need to renegotiate or reach an agreement every time a new shareholder or partner is added.
  • Renegotiate and vary: If you already have a Buy/Sell Agreement in place but it doesn’t contemplate adding anyone else then it will need to be renegotiated and varied. This means that everyone will need to agree to the changes. When you’re renegotiating, we’d recommend adding a Deed of Accession for the future.

#2. Does it deal with trauma?

When someone is seriously injured or unable to work for a long time, it can raise many questions:

  • How long will they be absent for?
  • Will they want to return to work? If so, when?
  • Will they be able to work full-time or only part-time?

Traditional Buy/Sell Agreements do not deal with these issues. If you put in place a robust yet flexible agreement at the outset, it will help you when you need it most.

The Agreement can:

  • Set timelines: The agreement can outline how long an ill partner can work part-time. It can also let the business use a lump sum insurance payout to hire a qualified person while the partner is recovering.
  • Outline when someone can return to work: Will a medical certificate be required? Can they work part-time? Can their role change?
  • Grant a power of attorney: This lets the remaining partners maintain control, make key business decisions and keep the business going. A power of attorney can even be triggered or revoked when certain events happen.

#3. How will the business be valued?

Determining business value is critical. Often business partners ‘draw a line in the sand’ and agree on what each person’s stake is worth. If this isn’t possible, you can value your business via an independent market valuation. Your agreement can state which one you should use.

An independent market valuation involves using an external party to value the business. They should take into account how the company will be affected when the partner leaves it. For example:

  • The payout figure should take into account whether the business profits will be reduced when the partner leaves; and
  • Any debts and increased expenses will need to be factored into the valuation.

These factors may mean that the valuation is discounted to allow the surviving business partners to go on.

If you set a minimum business value or floor price, the Buy/Sell Agreement should also outline how the funds are to be used. This may include:

  • Repaying the company’s outstanding debts;
  • Keeping the business on its feet as it is rebuilt. This may include employment costs and working capital; and
  • Paying out the departing business owner’s estate.

If you have insurance, this may state what the minimum value of each partner’s share is. You can allow for more flexibility by taking out higher insurance coverage. This is more expensive, but you won’t need to increase your insurance cover as frequently as your business grows.

#4. How often will you review it?

Just like your will, your Buy/Sell Agreement is not something you can set and forget. Revisit it regularly to make sure it still solves your succession planning needs.

This doesn’t mean that you continuously re-draft the agreement. We recommend you review it annually. You should also get it checked by a lawyer when there’s a significant change or every 3-4 years to make sure it’s fit for purpose.

Some things to ask yourself when reviewing the agreement include:

  • Has the business materially changed? Have you taken on more debt or employed more people? Does this change how the agreement works?
  • Has the value of the business materially changed? Does the valuation structure stand the test of time?
  • Is the limit of indemnity in your insurance policy still right? Should you buy more cover at a higher level?

#5. Is it backed with adequate funding?

Not everything can be covered by insurance, so your Buy/Sell Agreement should also have a contingency plan to cover the cost of buying out one of your partners. This may include:

  • Allowing for self-insurance or self-funding: By putting away some extra funds or dividends you can fund some or all of the transfer yourself. Alternatively, you may be able to borrow from the company.
  • Allowing for vendor finance: This means the remaining business owners can pay down the purchase price over a longer period of time with interest.
  • Including a ‘fall back’ finance clause: If the insurer does not pay out the purchase price, this clause will let you buy out the other partner by self-funding, vendor finance or another way.

If you would like help structuring your Buy/Sell arrangement or crafting an agreement to help you future-proof your business, get in touch. We’d be happy to help.

Author: Katie Johnston

September, 2018

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