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:
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:
#2. Does it deal with trauma?
When someone is seriously injured or unable to work for a long time, it can raise many questions:
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:
#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:
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:
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:
#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:
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