The Buy-Sell Agreement

Submitted by John Brown on Mon, 04/11/2016 - 5:00am
Business man carrying a brief case

There’s More To Life Than Death & Disability

In this article, we continue our discussion of BEI's Seven Step Exit Planning ProcessTM. This article and the next cover the issue of continuity: making sure an owner’s family and business are protected if the owner does not make it to his or her planned departure date. To review, we kicked off this series with a comparison of Exit Planning and succession planning and followed that with: setting the owner’s goals, the critical importance of defining cash flow and protecting business value. We have discussed both transfers to insiders (assessing the prospect for success and owner and successor expectations) and sales to third parties.

Most of our clients will leave their businesses vertically via the front door, rather horizontally under a sheet. Still, the focus of most buy-sell agreements is the “under-the-sheet exit” or close to it: the owner’s permanent disability. Too many buy-sell agreements fail to cover the many types of lifetime exits in which owners walk out the door for two simple reasons:

  1. Estate planning or business attorneys (at the suggestion of life insurance professionals) draft most buy-sell agreements. Naturally, these professionals focus on what they know.
  2. Lifetime ownership transfer events are challenging to design, fund, and execute. They are more complicated, complex and beyond the experience of those who design and draft “death and disability” buy-sell agreements.

As a result, the absence of lifetime events in buy-sell agreements leaves too many owners, their companies and their families exposed.

Show Me A Lifetime Event and I’ll Show You A Challenge

Common lifetime transfer events include an owner’s:

  • Sale of interest to an outside party
  • Retirement
  • Termination of employment by the company
  • Involuntary transfer due to bankruptcy or divorce decree
  • Dispute with other owners leading to a sale of ownership

As unpleasant as it is for owners to contemplate their death or permanent disability, those events are easy for advisors because we can easily define and fund them. But look again at that list of more challenging lifetime events.

  • On the day your client discovers that her co-owner is being sued and the co-owner’s ownership interest has attracted the attention of his litigious creditors, that’s challenging.
  • When one owner turns to the other and says, “You know, this really isn’t all I’d hoped it would be so I’m leaving for Tahiti tomorrow. I’ll call you to let you know where you can wire my half,” that’s challenging.
  • When you find out your client wants to buy out an uncooperative co-owner, that’s challenging.

To my knowledge, there is no insurance sold—at any price—that covers these and many other lifetime exits.

Your Job

As an Exit Planning advisor part of your job is to create, oversee, or contribute to business continuity agreements that cover both easy-to-fund and challenging (or unfunded) events because:

  1. Ownership transfers due to lifetime events occur far more frequently than do transfers caused by death or disability; and
  2. There are professional advisors who specialize in designing business continuity in the event of an owner’s death, but none—unless you pick up the baton—is devoted to planning for lifetime transfer events.

As Exit Planning advisors, we must have a seat at the table whenever business continuity is discussed.

Buy-Sell Agreements Can Launch The Comprehensive Exit Planning Discussion

A buy-sell agreement is a truncated form of an Exit Plan. Creating one necessarily includes the discussion of the owner’s ability to:

  1. leave the business on terms consistent with their exit goals, and
  2. acquire a departing owner’s interest at a price they can afford.

The focus on achieving an owner’s goals in the context of an unplanned exit leads logically to a discussion of achieving an owner’s goals in a planned exit. This relationship makes the buy-sell agreement a natural entry point for more comprehensive Exit Planning. A discussion of business continuity provides the ideal occasion for advisors to begin an Exit Planning dialog with owners.

In future articles we will discuss how to design an owner’s business continuity plan to address all ownership transfer events, not just the Big Two of death and disability.