What is a Buy/Sell Agreement?
In many aspects, a buy/sell agreement functions akin to an individual’s Will. It defines the process of transferring business interests. This legal agreement can be integrated into the organization’s bylaws or stand-alone. The intricacies involved in buying and selling a business interest in closely held non-public enterprises resemble the complexities of managing an estate without a properly drafted Will. The buy/sell agreement creates an atmosphere that promotes an orderly transfer of ownership by identifying the who, why, when, and how of a business interest transfer.
Transfers of Ownership: Who, What, When, Why, and How
Buy/sell agreements establish the parties involved in interest transfers, delineating who can sell, buy, or receive interest in the business. The vision created by the agreement becomes apparent during situations like the passing of an interest holder or the dissolution of a marriage, where the agreement can clearly define the inclusion of the interest holder’s spouse. Another consideration is what assets are included in the business. Occasionally, enterprises accumulate assets that are not used in the organization’s operation. As part of the agreement, specific assets can be included or excluded depending on the agreement between interest holders.
Considerations for Value
Determining the value of a business interest is a critical aspect of any buy/sell agreement. Several factors are considered when valuing a business interest:
- Financial Metrics: Traditional financial metrics such as revenue, profitability, and cash flow play a significant role in valuing a business.
- Market Analysis: Establishing a fair Consideration requires a review of the current market conditions and changes that are constantly taking place.
- Asset Valuation: Assessing the business’s tangible and intangible assets is crucial. The tangible assets held by an entity, such as property, equipment, and inventory, add to the value of a company. However, intangibles, including its customer base, brand recognition, and intellectual property, greatly influence and can significantly impact enterprise value.
- Future Earnings Potential: Projections of cash flow and earnings are essential to valuation. Forecasts anchored in historical data, market trends, and proprietary projects provide valuable information to determine future growth and value.
- Risk Assessment: Identifying risk is a crucial element in calculating value. Volatility, regulation, and dependence on individuals, whether within management or outside the business, can create potential risk. Such risks can influence the perceived value of the company. By considering these factors in the buy/sell agreement, parties can ensure a fair and accurate valuation of the business interest, reducing the likelihood of disputes and disagreements.
Who Needs a Buy/Sell Agreement?
While buy/sell agreements are essential for any non-public organization facing potential asset loss from legal disputes, they are particularly beneficial for:
- Family-Owned Businesses: Family-owned businesses often involve multiple generations and complex family dynamics. A buy/sell agreement can reduce potential conflict by providing clarity to ownership transfers and preserving business continuity.
- Partnerships and Joint Ventures: Businesses with multiple interest holders can benefit from the clarity provided by a buy/sell agreement, which can outline the conditions and terms of the transfer of ownership.
- Professional Practices: Professional practices such as medical, legal, or accounting firms rely heavily on the expertise and reputation of their practitioners.
- Startups and Emerging Businesses: Startups and emerging businesses often undergo rapid growth and change. A buy/sell agreement can create stability by regulating equity ownership, investment exits, and thought leader departures.
- Businesses with Key Employees: Businesses with key employees or shareholders whose departure could impact operations or value can benefit from a buy/sell agreement. Overall, most organizations can benefit from a well-drafted buy/sell agreement.
Final Thoughts
Incorporating these items in the buy/sell document can provide fair and accurate valuations and mitigate discord and disagreements. The tools provided by a buy/sell agreement can be indispensable.
At Teuscher Walpole, we always recommend a buy/sell agreement whenever the corporate structure has multiple owners or partnerships, regardless of how long relationships have existed.
