No one enters a relationship wanting to get jilted. It’s true whether you’re entering a business together or a marriage together – and the consequences can be even more painful if you’re doing both at the same time.
When two or more people want to co-own a business, the buy-sell agreement should be one of the first documents that is created. The buy-sell agreement determines what will happen if a co-owner wants to leave the business, retire, sell shares to someone else, dies or goes through a divorce. In essence, it protects everyone’s interests by establishing the procedure for setting the value of the business and the terms of a buyout.
Creating the agreement
Even though it may slightly dampen your enthusiasm of going into business together, you must have the conversation with your business partner or partners about what will happen if things don’t work out. It’s even more important to document these discussions in writing, spelling out how additional partners can be added, what a buyout would look like, and what has been established as the initial value of the business. I can’t stress enough how important it is to create this agreement.
For many business owners, the cost of creating a buy-sell agreement and the initial business valuation is an issue. Let’s look at professional services fees you’re already paying. Chances are, you have a retirement plan or other investments. And you’re probably paying a broker a percentage of your investment to manage those investments. You’re probably also paying premiums on life insurance as well as insurance on your home, business and vehicles. You’re already paying a fee to protect these assets, yet they pale in comparison to your biggest asset of all – the value of your business.
For other business owners, finding time to create a buy-sell agreement is difficult. You’re an entrepreneur. You want to spend your time working on your business. However, failing to take the time to protect your biggest asset can be devastating.
Let me provide a real life illustration of what can happen when a buy-sell agreement is not in place. A business owner’s wife has decided to leave him and is filing for divorce. He had poured most of the earnings back into the company over the past five years, growing the size, assets and viability of his company. He has also likely increased the value of the company – although he doesn’t know what that value is. With all the earnings going back into the company, the business owner has not diversified his wealth. How will he compensate his soon-to-be ex-spouse for her portion of the value of the business – when he does not have access to liquid assets? In general, this business owner should pursue a strategy that impacts the value of his business the least. He might also forego capital expenditures or incur additional debt to free up cash for the settlement.
The buy-sell agreement is definitely a case that proves having an ounce of prevention can be worth a pound of cure. Similar to an insurance policy, you’ll pay for the creation of a buy-sell agreement up front, hoping that you never need it. However, if you do, it will certainly simplify how your business affairs will be determined.
If you don’t have a buy-sell agreement, or you haven’t looked at the one you have in a while, be sure to talk to your accounting professional about it. By working proactively now, you won’t have to be reactive if you are faced with a traumatic situation later.