A well-drafted, current Buy-Sell Agreement is one of the most important tools a business owner has for planning for the future. It can keep ownership of the business in the family and can provide a market for the sale of the owner’s interest when he dies, retires, or becomes disabled. Many small business owners have a Buy-Sell Agreement that was drafted years, if not decades ago, when the business was formed. More likely than not, that Buy-Sell has not been looked at since, but has been put in a drawer where it is collecting dust. As a consequence, the Buy-Sell may no longer make sense in light of changed circumstances, such as changes in tax laws, changes in the marketplace, and changes to a business itself as, for example, the next generation begins to work in the business. Failure to update the Buy-Sell Agreement to take new circumstances into consideration may result in loss of value, disputes, and even litigation, and not the successful exit the owner envisioned.
Some of the common issues in a Buy-Sell Agreement that need to be periodically reviewed by a business owner and his lawyer are:
- Is the valuation mechanism clear, appropriate to the circumstances, and up-to-date? Many Buy-Sells have pricing formulas that are subject to conflicting interpretations: undefined terms may have meanings to appraisers or lawyers that differ dramatically from the owners’ expectations. Or, if a fixed price appears in the Buy-Sell Agreement, the price may be out of date or may no longer be appropriate to the changed nature of the business. For example, many Buy-Sells require annual updates of a fixed price (after the end of each fiscal year, for example), but, too frequently, business owners fail to amend the Buy-Sell every year to make sure that the fixed price reflects the realities of the business. Also, the Buy-Sell may not address whether valuation discounts should be applied and, if so, under what circumstances. Failure to make sure that the valuation mechanism contained in the Buy-Sell Agreement is clear, appropriate, and up-to-date may mean that a judge, rather than the business owners, will determine the price for the business interest.
- Does the Buy-Sell Agreement contain all of the relevant triggering events? Possible triggering events that may be ignored by the Buy-Sell include permanent disability, divorce, disclosure of confidential information, involuntary or voluntary termination of employment, or assignment of an ownership interest to a creditor. For example, if the Buy-Sell fails to provide for the purchase of an owner’s interest after his employment is involuntarily terminated due to some serious breach, the remaining owners may find themselves in the unpleasant situation of continuing to be co-owners with someone they no longer trust - a situation that is not only unpleasant but which may lead to disputes and even litigation.
- How does the Buy-Sell Agreement deal with children who work in the business and children who do not work in the business? Too often, Buy-Sells do not address the possible conflict between children who work in the business and those who do not. For example, it may be appropriate to provide for a series of “puts” and “calls” to address this potential conflict.
- Is the Buy-Sell Agreement consistent with the estate plans of the owners? If a Buy-Sell prohibits transfers of an ownership interest to any spouse of any owner, this may not be consistent with an owner’s estate plan that contemplates a transfer of assets to the surviving spouse. Or, the Buy-Sell Agreement may prohibit all lifetime transfers of ownership interests, which would restrict an owner’s ability to shift future appreciation to his children by lifetime gifts, or may contain such severe restrictions on transfer that lifetime gifting is not effective.
These are but a few of the issues that business owners need to periodically review so that the Buy-Sell Agreement can be a tool for giving effect to the owners’ wishes rather than a source of disagreement and dispute. To make sure that the Buy-Sell Agreement serves the purpose for which it is intended, business owners should dust off their Buy-Sell and consult with their legal advisors to make sure that the Agreement continues to reflect their wishes.