bonus checklists: 16 steps to reviewing a buy-sell agreement and 20 issues to consider.
by ed mendlowitz
77 ways to wow!
nobody needs an estate plan, exit plan or a buy-sell agreement. but their families and survivors do.
more: due diligence is in the details | simple controls can prevent fraud | charity directors must take theft seriously | forensic techniques can be fraud deterrence | the hazards of poor internal controls | rule #1: start with cash | the priorities were backward | how to read a financial statement | 77 thoughts about client needs
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estate plans are done so that the remaining family members can have liquidity, minor children will have guardians of your choosing with a dependable cash flow, children won’t fight (too much) over the money, people of your choice will collect and distribute assets and make transfers in an orderly manner, and estate and inheritance taxes can be minimized as can the costs of settling the estate.
succession or transition plans don’t matter for the person who drops dead, but not having things in order is very unfair to your family or those who work in the business or who depend on it. there also can be very large costs to wind down a business and close it up. and possibly the owner won’t drop dead but will become disabled and would need cash flow from the business. then, they would really be screwed – and by their own doing!
a buy-sell agreement is a will for a business. if an owner drops dead or suddenly is disabled, the lack of an agreement will cause fights between the remaining owners and the dead owner’s family. not “may” cause, but “will” cause.
selfish self-centered boors don’t protect their families by setting things up so that there will be a minimum disruption during a usually upsetting period.
do it right! get your affairs in order. get the buy-sell agreement or business continuation plan done. pronto!
clients who are a part-owner of a privately held business need a buy-sell agreement. such an agreement is a will for the business. it is not sensible to neglect having a will, and avoiding suitable arrangements for a business is equally negligent.
a buy-sell agreement not only protects the owners’ families for the value of their business interests, but also protects the surviving owners because the transfer of the disabled or deceased partner’s ownership will be easier because a method of transfer, payment and terms are established. this reduces or eliminates any unpleasant negotiations between the deceased or disabled owner’s family and the surviving owners.
these agreements have various names depending upon the nature of the entity, and can be referred to as shareholders’ agreements, buy-sell agreements, members’ agreements or partnership agreements. whatever their name, they serve the same purpose – to say what happens to ownership shares following a disability or death.
the agreements can be with the entity or separately with the other owners.
taxes and sources of cash for the payments would be a consideration to determine the format of the agreement. the business’ accountant is usually the most knowledgeable financial advisor for the owners and can help them work out the best format for their business.
these agreements can also provide for transfers upon retirement, a desire to leave the business for any other reason, personal bankruptcy, loss of professional license or suspension of practice, conviction of a crime and restrictions of transfer to outsiders.
if a client does not have an agreement, it is suggested they consider preparing one forthwith.
they owe it to themselves, their family and partners. if a client has an agreement, good for them, but it should be reviewed periodically – perhaps initially and then once every two or three years thereafter, or if there are significant changes in the business, cash flow, owner relationships, the need for large borrowing or additional capital in the business for current applicability and values.
what to do with an existing agreement
checklist: 16-item buy-sell agreement review
- obtain a copy of the executed agreement.
- review the agreement for the value or the method of calculating the value.
- calculate the value following the method stated in the agreement.
- compare the calculation to the current financial statement and have a discussion of the validity or applicability of that value.
- project the value in five years using the method described in the agreement.
- review that there is a method to update the value to keep it current.
- review the payment terms and discuss with the client to determine their awareness of whether the business or remaining owner(s) could afford to make the payments.
- determine if the agreement covers death, disability, personal bankruptcy, retirement or someone wanting to leave.
- discuss the definition of disability with the client to determine whether it is clear and objective.
- does the agreement cover an owner getting sick for a prolonged period, i.e., three or four months or longer, and their salary payments or draw?
- if there are more than two owners, does the agreement cover the possibility that two owners might need to be paid out at the same time?
- is there a non-compete agreement?
- remind the owners that either one can be either the buyer or seller irrespective of the differences in age between them.
- have them consider life insurance or disability buyout insurance. each owner should be responsible for their own disability income policy.
- use as a guide the “buy-sell agreement issues to consider checklist” below.
- if anything is vague it should be recommended that the client consult with their attorney.
what to do in considering a buy-sell agreement
following is a checklist that can be used at a meeting to advise clients about what should be in the buy-sell agreement.
(note that these checklists are provided for instructional and guidance purposes and should be further discussed with clients for business issue purposes and then with an attorney who would also prepare the actual agreement.)
checklist: 20 buy-sell agreement issues to consider
1. parties to agreement
- should be all shareholders, partners, members or owners
- will the business be a primary, secondary or default party, or not be a party to the agreement?
- should there be prohibitions or restrictions on transfers to family members or trusts for their benefits, or transfers through a will? suppose one owner wants to make transfers for estate tax purposes?
2. form of agreement
- buy-sell – this is where the entity will repurchase the interest.
- cross purchase – this is where the agreement is between each partner or owner and not with the entity.
- the agreement should state whether the purchase is mandatory or optional (usually the offer to sell is mandatory).
3. value of business
- how business will be valued?
- will a “fair market value” valuation prepared?
- will there be a formula or periodic revaluation?
- a default purchase price formula should be set.
- will valuation discounts be considered in determining the buyout price?
- will book value, or will parts of book value be treated separately?
- if a valuation is required, the agreement should state how it should be done and by whom.
4. compensation
- this can be covered in the shareholders’ agreement, or in a separate compensation or employment agreement. either way, it is an issue that must be covered.
- how salaries will be paid
- how bonuses will be paid
- you should cover how sep, 401(k), pension plan or similar type of payments will be figured in as compensation.
- will there be any minimum work or time requirements?
- what will compensation be in case of disability – suggestion is for full salary for three months, half salary for three more months and then nothing.
- what happens upon termination of employment – is a sale triggered or can the shares be retained?
5. profits and losses
- how will profits and losses be divided?
- will there be distinctions between different categories of income, such as ordinary income divided one way, capital gains another and depreciation a different way?
- how will cash flow be divided if it’s different from the profits?
6. decisions
- how decisions will be made? suggestion: equally or based on ownership percent
- how are deadlocks handled?
- what decisions are unanimous? suggestion: decisions to admit a new partner, moving the office, borrowing, or involving individual items over a certain amount
- policy toward spouses, children and other relatives working in business
7. voluntary buyout
- for any reason except death, disability, retirement or any other reason that is specifically covered
- need price determination and terms or payout
- consider what happens if remaining people do not want to do buyout.
- is there a dissolution?
- will person originally requesting buyout get the opportunity to buy out those refusing for the same price or a discounted amount and more extended terms?
8. buyout upon death
- need price determination and terms or payout
- consider whether life insurance is wanted and how quickly payment will be made after receipt of the proceeds from the insurance company. what happens if not all parties are insurable?
9. disability buyout
- need price determination and terms of payout
- need determination of definition of disability
- need determination of period of disability that will trigger buyout. suggestion: eighteen months after start of disability, the disabled partner must sell his partnership interest under the same terms as a voluntary buyout if the partner was disabled and unable to perform his full duties for at least 15 of those months.
- consider whether disability buy-sell insurance is wanted and how quickly payment will be made after receipt of the proceeds from the insurance company. also consider what will happen to insurance proceeds if they are received before the buyout is triggered under the agreement, and disabled returns to work.
10. buyout on losing license
- need price determination and terms of payout
- will employment be terminated or continued?
11. buyout on personal bankruptcy
- need price determination and terms of payout
- will employment be continued?
12. retirement buyout
- need price determination and terms of payout
- age after which retirement can or must start
- minimum notice required
13. funding
- will funding be done on a regular basis, or after the buyout event occurs?
- will and/or can current funding be on a tax-advantaged basis for buyer or seller?
14. restrictive covenants
- what restrictions will be placed on the person being bought out from working in the profession or industry, and for how long, and within what geographic area?
- restrictions apply to being in business or having executive or key positions and approaching or soliciting customers, suppliers and employees, as well as using or applying any competitive information obtained while employed by the company.
15. taxability of payments
- how will the payments be deducted and how will they be taxed to the person being bought out?
- the taxability of payments will be based upon how the purchase price is allocated.
- if there are payments for intangibles, the parties will agree to the allocation.
16. ownership of non-operating, investment or intellectual property
- how will non-operating assets be treated (such as artwork in offices)?
- how will investment assets be treated?
- who will own copyrights and patents – will royalties be payable to person leaving?
17. vacation, personal and sick days
- how much vacation, personal and sick days will each owner be permitted?
- how much will be the most consecutive time off that can be taken?
- will untaken time be cumulative from one year to the next or lost?
18. other business ventures
- will this be permitted and if so under what conditions?
19. timing of signing of agreement
- agreement should be executed before shares are issued or business commences.
- if entity is operating, should be executed as quickly as possible.
- best time is when either party, or their family, could be the buyer or seller.
20. separate advisors
- each party should have their own advisors and attorneys.
