Transitions Digest

The 30,000 Mile Checklist

In the prior two issues of this newsletter, we’ve looked at several key elements of your buy-sell agreement and the transfer events that can trigger a buyout. Today, we look at all the types of changes (in you, your partners, your company, your finances and your industry) that can transform that vigorous buy-sell you created years ago into a lumbering, but potentially dangerous, dinosaur. In this issue you’ll also find a checklist that will help you assess the viability of your buy-sell agreement.

PEOPLE CHANGE

Shareholders are living, breathing creatures. In addition to all the “bad things” (or transfer events) that we discussed in previous issues, shareholders will age. As they do, they may adjust how much they want to work or what goals they want to work toward. If shareholders are all of a common age, they may share these changes or they may not. If one shareholder is older than one or more of the others, the commitment to work long hours or the long-term ownership goals of the older and younger shareholder can diverge. Should that happen, the only effective recourse may well lie in the provisions of a well drafted, comprehensive and current buy-sell agreement.

COMPANIES CHANGE

The most common change in the life of a successful business is its increase in value. When the company isn’t worth much, shareholders may be able to buy each other out if certain events occur. As the company becomes more valuable, however, shareholders cannot put together the resources necessary to cash each other out.Also, over time, the ownership of companies changes as new owners buy in and older ones sell out and retire. As these changes occur, the ownership proportions can change in ways not intended or planned by the majority shareholders. The buy-sell agreement can respond by allowing ownership, but not voting control, to shift to the younger, incoming generation of owners.

INDUSTRIES CHANGE

Like it or not, the industries we are in affect the value of our companies. If we’re in a niche or “hot” industry, buyers will pay more for our companies and values reflect that demand. If there is a great deal of industry consolidation going on, the value of your company will reflect that. Similarly, industries go through boom and bust cycles and if the company is enduring the bust part of the cycle, its value reflects that downward pressure as well. Buy-sell agreements can be drafted to reflect not only rapid changes in value, but also corresponding changes in the terms (length of buyout, amount of down payment, mandatory vs. optional purchase, etc.) of any purchase. This tends to prevent one owner from “gaming” the buy-sell agreement by selling out when value peaks.

BUYOUT REQUIREMENTS CHANGE

When you created your buy-sell agreement, you made decisions about whether particular events would trigger an optional or a mandatory buy out. You made those decisions based on then current factors. As the foundation for those decisions may have changed so too do your preferences. For example, you now may prefer that a child or a key employee acquires your ownership when you retire or die, rather than the other co-owner.

THE ABILITY TO SELL OUT CHANGES

When your company was worth very little, it would have been highly unlikely for an unrelated third party to approach you with a lucrative offer to buy. Now that your company may be more valuable, however, the possibility that a third party would make an offer is a real possibility. Does your buy-sell agreement adequately address this? What if one owner wants to sell and the other doesn’t? Does it make a difference whether you are the owner who wants to sell or the owner who doesn’t want to sell? Given all the moving parts, it makes sense to review your buy-sell agreement at least every year. The following checklist is designed to give you and your advisors a snapshot of your buy-sell agreement. The purpose is to help you identify those areas that should be updated for all the reasons discussed here.

Buy-Sell Transfer Event Checklist

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

Posted on October 15th, 2008 under Exit Planning, Exit Planning Digest. Tags: 30000 mile checklist, bi-monthly newsletter, business brokers, business changes, business for sale, business planning, buy-sell agreement, buy-sell agreements, buy-sell transfer, buyout, companies change, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: “Should I Sell My Business Now?, industries change, part two, retire, retirement, shareholder, shareholders, Strategic Exit Plan, Strategic Exit Planning, update. Comments: None

 The Exit Planning Review™ Bi-Monthly Newsletter

In the previous issue of The Exit Planning Review™, we discussed what a buy-sell agreement is and why you should dust it off, take a second look at it, and call your advisors to update it.If you just aren’t convinced that setting up that meeting is all that important, in this issue, we’ll look at the events that can (and do) crop up in the life of a business and that can be handled by a carefully designed, frequently updated buy-sell agreement. Once you see how one agreement can impartially and fairly treat all parties when bad things happen, we think you’ll make that call.

TRANSFER EVENTS

Buy-sell agreements can be designed to handle the unhappiness that can arise when any of the following events happen to the shareholders of a closely held company:

• Death of a shareholder
• Disability of a shareholder
• Divorce of a shareholder
• Bankruptcy of a shareholder
• Sale of part or all of the company to a third party
• Retirement of a shareholder
• Involuntary termination of a shareholder
• Business dispute among shareholders

You probably have no trouble imagining how most of these events (the death or disability of a shareholder, for example) could cripple your company or your family if left unaddressed. But some events, like the involuntary termination of a shareholder, are harder to grasp.

Rarely do owners anticipate that one day they might have to terminate the services of another shareholder. If they can imagine that scenario, it is rarer still that they can imagine the thorny problems that will arise. Is the terminated shareholder required to sell back his stock? Is the remaining shareholder or the company required to purchase it? In a divorce scenario (especially in a community property state) do you run the risk of ending up with your co-owner’s ex-spouse as a new co-owner?

Let’s look at a few all-too-common problems that well-written buy-sell agreement can solve.

Sale of Part or All of Company to a Third Party

You receive a call from a legitimate representative of a deep-pocketed Private Equity Group who has identified your company as an acquisition candidate. He makes an initial offer that would guarantee your family’s financial security for life. Imagine your surprise as your 25 percent co-owner responds to your announcement, “Thanks, but no thanks. I’m just getting started and think we can take this company to the next level ourselves!” You call the PEG back to offer your stock for sale, but the PEG (like almost every third party owner) isn’t interested in buying a part of your company. It is an all or nothing offer. Since your buy-sell agreement doesn’t address this issue, you hang up and return to work.

A well-crafted buy-sell agreement can stipulate that when a third party makes an offer to buy a company’s stock, the other shareholders must match that offer or must sell their shares to that third party.

Firing a Shareholder

Twenty years ago Ned, Kathy and Jim left a common employer and started their company. The three equal shareholders knew exactly what they’d do differently and agreed on how hard they’d all work to reach their common goals. During the last five years however, Jim’s behavior was becoming unpredictable. He missed important customer meetings, ignored his department’s performance and finally, was arrested for soliciting an undercover policewoman in a well-publicized sting. In an attempt to calm vendors and customers and to restore employee morale, Ned and Kathy asked Jim to resign. He refused. They reluctantly told Jim that he’d have to leave and that they’d purchase his stock at the value agreed upon in the buy-sell agreement. Jim pointed out to his co-owners that their buy-sell agreement did not mention the involuntary “retirement” of a shareholder and refused to sell his shares.

A carefully considered buy-sell agreement can stipulate not only that a fired shareholder must sell his or her shares for the agreed upon value, but also that the remaining shareholders must pay for that stock.

Divorce of a Shareholder

When Mike and Patrick went into business 15 years ago, they agreed on everything — except women. Neither could imagine what the other one saw in the other’s wife, but had managed the situation by maintaining a polite distance.

One Saturday night, Mike called Patrick to ask if he could stay at Patrick’s house because his wife had kicked him out. The following week, Mike was served with divorce papers and within days, Mike’s attorney scheduled a meeting with both men. Patrick’s initial curiosity about why he was involved turned to anger when the attorney told them that Mike’s wife wanted, and, in their community property state had a right to, half of Mike’s share of the company. If the three of them couldn’t run the company together, Patrick would have to buy both of them out and Mike’s wife had an especially unrealistic idea of what her share was worth.

Mike and Patrick turned to their buy-sell agreement hoping they’d thought to plan for this event. They had not. Their agreement did not include a divorce provision.

We are happy to send you information about any transfer events that your buy-sell should cover. In the next issue, we’ll talk about how changes in your company can turn the buy-sell decisions you made in the past into less-than desirable solutions today.

Subsequent issues of The Exit Planning Digest discuss all aspects of Exit Planning. The provider of this Newsletter (Holly Magister, CPA, CFP®) offers you unbiased information about what you may need to know. Subscribe to our free Exit Planning educational newsletter to learn more about how to grow and/or plan for your business exit.

Posted on October 6th, 2008 under Exit Planning, Exit Planning Digest, Uncategorized. Tags: "Does Your Buy-Sell Cover Everything it Should?", bi-monthly newsletter, business brokers, business for sale, business planning, buy-sell agreements, Enterprise Transitions, Entrepreneur, Entrepreneurs, Entreprenuer, Entreprenuers, Exit Panning Review, Exit Planning, Exit Planning Review: “Should I Sell My Business Now?, part two, retire, retirement, shareholder, Strategic Exit Plan, Strategic Exit Planning. Comments: 2