For the past several weeks, we have described the seven most common problems we see in business owners’ buy-sell agreements (BSAs).
In this article we collect, in one place, a summary of our recommendations for addressing each of the seven.
Hole 1: Ignores Threats To Business Continuity
At best, BSAs that deal with the transfer of ownership at an owner’s death (and sometimes disability) only ensure that a surviving owner(s) owns all of the company and that the deceased owner’s estate receives fair value, in cash, for the transfer of ownership. It does not ensure that the business will continue.
1. Address business continuity risks resulting from an owner’s departure. These include loss of the personal guarantees, collateral and talents that are essential to the business that the departing owner provided.
2. Consider including in your planning recommendations, the drafting of releases for existing and contingent debt obligations and requests for written assurance from lenders that adequate insurance or replacement capital will satisfy removal of deceased owner’s guarantees.
3. Also, develop, now, a plan to mitigate the loss of a key employee/owner by hiring and training others in the organization whose talents can offset the loss. Key person insurance should also be considered on those owners who are key to the ongoing success of the business.
Hole 2: Ignores Common Lifetime Exits
The disability, divorce, bankruptcy, termination of employment or retirement of an owner, or business dispute among owners can trigger the need to transfer ownership and are more likely to occur than the death of an owner. Failing to provide for these events can wreak havoc for all parties, including the company.
1. Explain that the likelihood of a lifetime event triggering an ownership transfer issue is much greater than the likelihood of an owner’s death. That exercise often motivates owners to update, revise and expand the scope of their BSAs.
2. Explain advantages of discussing and agreeing upon provisions (including valuation) dealing with involuntary lifetime transfers before they apply to any of the owners. When owners don’t know whether they will be the buyer or the seller, the focus is on fair dealing.
3. Recommend an experienced attorney who knows whether state law precludes certain approaches, and can draft provisions that protect all of the owners.
Hole 3: Neglects The Decedent’s Family
Most BSAs focus exclusively on the benefits they provide to the surviving owner(s), and fail to provide to consider the financial consequences of an owner’s death and consequent loss of ownership to that owner’s family.
1. Ask owners about their plan for the future of their family without them. Questions such as: “If you die, what will replace your income stream for your family?” “Do you want your family to maintain its current income after you?” “Do you want all of your goals to be realized if you die, become disabled, or otherwise exit the business unexpectedly?” This discussion can broaden the scope of your representation far beyond buy-sell planning.
2. Involve spouses, at least in initial planning meeting(s), to alert non-business-active spouses to the consequences to them (and their families) should their spouses exit their businesses by death or otherwise.
3. Determine whether a gap exists between the financial resources available at an owner’s death (including the money received from the sale of ownership pursuant to the BSA), and the financial resources the surviving family will need to maintain its lifestyle should the owner die.
Hole 4: Isn’t Up To The Task
Many BSAs don’t consider the complex nature and relationships of the owners who sign them. For example, the BSA may not consider the consequence of having two owners, one who is insurable and one who is not.
1. Understand how different ownership scenarios create a different set of considerations regarding the optional or mandatory purchase or sale of an ownership interest.
2. Use the discussion of BSAs as an opportunity to engage owners in a deeper conversation about their thoughts on whether, under various scenarios, the buyer must purchase the seller’s ownership or have an option to do so; and if the seller must sell or have the option to sell.
Hole 5: Uses A Cookie-Cutter Valuation Formula
The valuation methodology (e.g. agreed-upon value or book value) contained in most BSAs may be adequate when a business first forms, but does not adjust to account for business growth.
Recommend the type of valuation that:
- Is appropriate based on the purpose of the valuation
- Matches the sophistication of the business
- Matches the owners’ willingness to pay
Hole 6: Is Outdated
BSAs don’t account for changes in the business since the original BSA was signed.
1. Make reviewing the BSA an annual event, perhaps part of your fiscal year-end reviews.
2. Confirm that, during your BSA reviews, you are reviewing the signed BSA, not an unsigned draft.
Hole 7: Is Poorly Implemented
If insurance funding is lacking, insufficient, or beneficiary and ownership of insurance is incorrect, BSAs cannot serve their purpose.
Look both inside and outside of the BSA for changes that can affect its efficacy.
Opportunities For Advisors
1. When you suggest to clients that you review their BSAs, describe the gaping holes that you think might apply and how you help owners address them.
2. Using questions to frame the discussion of the BSA review provides a terrific gateway to a deeper discussion of an owner’s Exit Planning goals.
3. Because even well drafted BSAs are generally written too narrowly (covering only death and perhaps disability) and don’t consider all, or even the most likely, transfer scenarios, they present the opportunity to explore and help create effective solutions.
4. Owners generally don’t consider the consequences to them if they become the remaining owner. Talking about that possibility is an opportunity to engage all owners in an Exit Planning discussion.
5. Owners generally don’t consider the consequences to their families should they be the owner who exits the business. Talking about that possibility is an opportunity to engage all owners in an Exit Planning discussion.
As Exit Planners, we view business continuity in the context of an owner’s exit goals. This means that a BSA, if triggered, must achieve the goals of both the remaining owner and the departing owner. Few BSAs, in our experience, measure up to this standard. Taking the time to thoroughly review an owner’s business continuity planning from an Exit Planning perspective provides you an unparalleled opportunity to demonstrate to owners that you’ve “got their backs” today as well as on the day that they need to rely on those agreements.
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