Complete A Buy-Sell Agreement (The Right Way) With A Valuations Expert
If you are a co-owner of a business, the first thing you should have completed is a buy-sell agreement. This agreement maps out the steps that will be taken if a co-owner leaves the business, sells their shares in the business to someone else, retires or passes away. This agreement is a contract among shareholders that determines what happens to the business’s stock using prior-determined guidelines. Read on to learn more.
Read Also: It’s Time To Update Your Buy-Sell Agreement
Think of the buy-sell agreement as a safety net. With one in place, it protects everybody’s interests by laying out the procedure for establishing the true value of the business and the terms of a buyout. Nobody goes into a business relationship thinking that someday they or their partner will leave the business but a buy-sell agreement is still important to ensure protection for all parties involved.
When you and your fellow business owners are drafting your buy-sell agreement, the following agreement types will be your likely options.
Cross Purchase Agreement
This structure is used when there will be a change in ownership and the shares in the business will be crossed over to another owner.
Stock Redemption Agreement
This agreement type puts the focus on the business. What I mean by that is if shares are exchanged, the business will repurchase them. With this in place, you can feel more confident because you’ll be able to sell shares back to the business, if needed.
This type is exactly how it sounds. You will have the option to sell your shares back to the business or on to other owners. With this option, you will have more flexibility to both sell and purchase more shares, and this will help make sure shares stay with their original owners.
Update, Update, Update!
Just drafting up a buy-sell agreement isn’t enough. It’s important for this document to be strictly followed as written and updated regularly to reflect the current value of the business.
If the valuation procedure of your business isn’t up-to-date in the document, the results could be devastating. These nightmare scenarios can happen if a business experiences any changes after the agreement was completed. This could lead to an overvaluation of the business which causes shares to be priced too high, leaving no available market for them. Furthermore, the opposite effect could happen if the business is valued too low. If the terms of the buy-sell agreement are sold at a bargain price and if you are the seller that would not be a desirable outcome. If shareholders are brought into the business, make sure they follow the buy-sell agreement policies to avoid headaches and problems.
I recall from my own experience, a buy-sell agreement that set the value of a company at $50,000 and never updated it for twenty years! It was finally calculated and the current value of the company was found to be $3 million. How would you feel if you had to leave the company and the value was set at $50,000?
Don’t Go It Alone
There’s no easy formula to calculate your business’s true value for a buy-sell agreement. That’s why having a business valuations expert assist you with the process is vital. Since each business has its own unique circumstances, a valuation has to be thorough and specifically catered for your unique situation. With that, I recommend that every business owner review their buy-sell agreement at least once a year from a legal and valuation perspective. Doing this will help you avoid expensive headaches in the future.
If you want more helpful insights and information about business valuations, check out our page to have everything at your fingertips.
Email Rea & Associates to be put into contact with our team of business valuation experts today for help updating your company’s buy-sell agreement.
By Tim McDaniel, CPA/ABV, ASA, CBA (Dublin office)