It’s common for businesses, in Houston as well as other locations, with more than one owner to need a buy-sell agreement to handle voluntary and involuntary ownership transfers. It’s also important to update the agreement regularly to ensure it’s still valid and addresses all of the business valuation issues that may arise.
Determine which structure is right for the business
In order to give the company’s remaining owners the right to buy a departing owner’s interest either in one lump sum or in installments, cross-purchase agreements should be used, depending on how the agreement is written. The purchase may be funded by insurance, if triggered by an owner’s death or disability.
Alternatively, redemption agreements allow the company to purchase the departing owner’s interest. By reducing the number of outstanding shares, the value is effectively transferred to the remaining owners. Redemption agreements also may be funded by insurance policies in which the company is named as the beneficiary.
Establish what valuation issues need to be covered
When owners face a “triggering event,” such as the death of an owner, a divorce of married shareholders or a shareholder dispute, emotions tend to run high. The departing owner (or his or her estate) suddenly is in the position of a seller who wants to maximize buyout proceeds. The buyer’s role is played by either the other owners or the business itself — and it’s in the buyer’s financial interest to pay as little as possible. In order to take away the guesswork and help ensure that all parties are treated equitably, a comprehensive buy-sell agreement can be used.
To minimize surprises when a buyout occurs, some owners decide to have the business valued annually. Because the value of the interest is likely to change as the business grows and market conditions evolve, this is often preferable to using a static valuation formula in the buy-sell agreement
At a minimum, the buy-sell agreement needs to prescribe valuation protocol to follow when the agreement is triggered, including:
- How “value” will be defined,
- Who will value the business,
- Whether valuation discounts will apply,
- Who will pay appraisal fees, and
- What the timeline will be for the valuation process.
When valuing the business interest, it’s also important to discuss the appropriate “as of” date. Timing may be critical because the loss of a key person could affect the value of a business interest.
The importance of acting now
When business owners are young and healthy and shareholder relations are strong, business owners tend to put planning issues on the back burner. But the more details that are put in place today, the easier it will be for owners to resolve issues when it’s time for a buyout. Also, it’s important to periodically review the buy-sell agreement once it’s in place, as business values tend to change over time.