If you’re just getting started in your business, it can be overwhelming to know what needs to be done aside from running the business.
And if you’re part of a joint venture, a Buy-Sell Agreement HAS to be one of those things you have for your business.
Here at Consolidated Planning, our goal is to help you protect, grow and ultimately exit your business with the right strategy to make it happen on your terms.
In this article, we’ll help you understand the four key factors that you’ll want your Buy-Sell Agreement to include and how that helps protect your business and all parties involved.
What Is A Buy-Sell Agreement And Why Is It Important For Your Business?
A Buy-Sell Agreement is yet another agreement to help protect that business you’re working so hard to build. These agreements provide direction on what should happen in terms of death, disability, retirement, or simply an owner stepping away from their business.
With the many unknowns in life, Buy-Sell Agreements are valuable (and essential) tools for maintaining control and stability within your business and any unforeseen events. However, these agreements can become increasingly complex as the number of business owners increases.
Let’s take a look at four reasons the right Buy-Sell Agreement especially matters when you are part of a joint venture.
#1 Calculate Your Business Value
When it comes to your business, everything really starts with your business value. A calculation of business value means fully understanding how much each person’s share of the business is worth, so each shareholder knows where they stand and how fair decisions can be made.
A business valuation is similar to your home appraisal. It’s very murky as to what your business is really worth. You may have a sense, or at least an opinion, but you don’t really know until you calculate this.
From a planning standpoint, completing a business valuation is essential to establishing the right Buy-Sell Agreement between you and your shareholders. With this calculator of business value, you’re going to make really important business decisions that are contingent on the expectation of a certain dollar amount.
What’s important here is that both (or all) parties understand and agree on the calculation of business value.
#2 Determine The Methodology Of Business Value And Timing
Once you’ve agreed on the calculation of business value, you must determine the methodology AND the timing.
While there are several options to consider, here are a few you might want to explore:
- Yearly Amendment To The Agreement: With a yearly amendment, you and your shareholder(s) will simply agree on the new business value and include it as an amendment to your existing Buy-Sell Agreement.
- Third Party Evaluation: Today there are countless third party appraisers or online tools to calculate your business value. With a 50/50 split business, it’s a good idea to attain two separate third party evaluations and meet somewhere in the middle.
- Multiple of EBITDA: Calculating the business value by applying a multiple to its Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). This multiple is often based on industry standards, comparable transactions, or the business’ specific financial performance.
- Revenue-Based Formula: Using a formula that considers your business’ revenue as a primary factor in determining its value. This may involve applying a multiplier to its revenue or using other revenue-based metrics to arrive at the valuation.
For whichever method all parties agree on, how often will you review and update your business valuation? It’s a good idea to do this annually. After all, your business will likely be the largest asset on your balance sheet.
Your method can be changed yearly but again, all parties must agree and sign off on this amendment.
#3 Determine A Method To Handle Disagreements When Your Business Is Split 50/50
When it comes to making decisions in your business, a business that is split 50/50 can pose some obstacles in the instance of a disagreement. When you’ve reached a stalemate in decision making because of the inability for shareholders to come to an agreement, your business operations may be impacted.
Because of this you need both a method and a remedy for handling disagreements when and if they arise.
Even though your business may be split 50/50, there, somehow, has to be a deciding vote. This is where a “texas shootout” is beneficial for the resolution of a deadlock situation in a 50:50 deadlocked joint venture.
For this reason, having a properly structured Buy-Sell Agreement provides a clear process for resolutions and has been agreed upon by all parties should a Deadlock ever arise.
#4 Set Clear Terms For What Happens In The Business At Death And Disability
When it comes to death and disability, it’s essential to know what happens to each shareholder’s shares.
At death, are there payout terms that are reasonable? Reasonable means it takes a long time to complete the payout. If you’re suddenly without your key employee who is an owner, the living partner has to come up with a lot more cash, with far less manpower. While the remaining owner has all of the equity in the business at this point in time, payout terms can cause havoc. For example, if both shares are worth 5M, the remaining owner owes 5M in the payout, meaning the business must earn 8M to 9M to pay out that 5M.
We often see that payout terms tend to be 3 to 5 years when they really should be double that.
A business that has lost an owner is usually under extra duress, and having to potentially increase revenue during this period of time to pay back the departing owner in a short number of years is unrealistic. Of course, life insurance or disability buy-out insurance can create a big down payment or completely pay off what the remaining owner might owe, but care should be taken for reasonable payoff terms when insurance isn’t available.
According to the Council for Disability Awareness, it is estimated that one in seven people will suffer from a long-term disability lasting five years or more before age 65. Even with more people being disabled before the age of 65, than dying before 65, disability is rarely adequately, or if all, covered when it comes to Buy-Sell Agreements.
Without adequately addressing death AND disability, strife and contention arises when it could have been avoided with a properly structured agreement.
Does Your Buy-Sell Agreement Adequately Protect You And Your Business?
Without a Buy-Sell Agreement that covers these four key areas, you’re failing to protect the future of your business as its success is dependent upon you and your shareholders showing up each and every day.
Once you have the business maturity, you’ll have the need to revisit these documents and continually ensure that you’re doing all the right things for your business, which is an important asset for yourself and others. This might include:
- Shareholder Agreement
- Insurance Policies, and
- Tax Efficiencies
To review or establish a shareholder agreement, talk with an experienced business planning professional at Consolidated Planning to understand the best structure for your business.
7054544.1 Exp. 9/2026
Guardian, its subsidiaries, agents and employees do not provide tax, legal, or accounting advice. Consult your tax, legal, or accounting professional regarding your individual situation. The information provided is based on our general understanding of the subject matter discussed and is for informational purposes only.
This material contains the current opinions of Andy Brincefield and Consolidated Planning only. These are not the opinions of Park Avenue Securities, Guardian, or its subsidiaries.
