As part of our transition advisory work, one of the first things we look at is a company’s buy-sell agreement. It is rarely the case that we find these agreements in good shape. It is far more common to find that an agreement is:
- Old and out-of-date,
- Contains blurry language about how the business is valued,
- Lacks proper levels of funding for life insurance, or
- Contains terms that could be harmful to the company in the event of a transaction between stockholders.
The principal reason a buy-sell agreement becomes outdated is that many business owners categorize it as a standard corporate legal document that sits in a drawer and is only pulled out if needed. This is a serious mistake.
Since a private company’s shares do not trade in liquid markets, the buy-sell agreement is the only document that governs transactions in the company’s shares. The agreement should serve the following purposes:
- It should reflect the bargain that the shareholders reach with each other in terms of how shares will be bought and sold and what triggering events would cause share transactions.
- It should be fair to all of the shareholders.
- It should protect the shareholders and their families by providing liquidity in the event of the death or disability of a shareholder.
- It should protect the company from unplanned liquidity events that could jeopardize its solvency.
- It should be clear and easily understood to avoid disputes
- It should be a living document that is reviewed annually and amended as the business changes.
A private company owner’s single biggest asset is usually the stock in their company, yet we find that many do not have a clear picture of how that stock is valued, how it is transferred, or how transactions will get funded.
Here are a handful of basic, key questions to ask yourself about your buy-sell agreement. If you cannot answer “yes” to all of them, it’s time to revisit your agreement.
- Do I clearly understand the value of my shares on an annual basis?
- Do I clearly understand the terms and conditions under various transaction triggers such as death, disability, retirement, separation from service, sale, divorce, etc.?
- Is the insurance coverage related to my buy-sell agreement adequate to cover the share values in case of the death or disability of a shareholder?
- Do I clearly understand the payment terms for triggering events so that I know the company will be able to fund the transactions without presenting a risk to its liquidity and solvency?
- Do I understand how our buy-sell agreement affects our estate planning strategy?
Public companies know the value of their shares at any given moment because they are valued and exchanged daily. So then, is it reasonable for you to understand the value of your biggest investment at least annually?
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