Anyone who’s wrangled over the value of marital assets in a divorce understands the value of a well-drafted prenuptial agreement. For the same reason, closely held businesses with multiple owners need a buy-sell agreement. A buy-sell agreement is a legal document that spells out how to value ownership interests and how and when owners may sell those interests. More importantly, a buy-sell agreement can provide a source of funding for the purchase of an owner’s interest in the business in case of death or disability.
A “standard” buy-sell agreement may prevent the sale of an owner’s interest in the company to anyone but another owner, or require consent of all other owners to bring in a new owner. If an outsider makes an offer, there may be first rights of refusal that allow either the company or individual owners to match the terms of the offer.
In addition, a buy-sell agreement should provide for a valuation method to minimize disagreement over how much money an owner gets for his or her share of the company. Valuation methodologies come in all shapes and sizes, and some are more appropriate than others depending on the nature of the business. And while mathematical formulas relating to multiples of earnings offer a quick answer, it is rare if ever that a simple equation will correlate to the true “going concern” value of a company. For those reasons, many buy-sell agreements contain a default provision requiring the owners to hire a qualified business appraiser to value the business if the owners can’t agree.
The buy-sell agreement also may require a mandatory company buy-back of an owner’s interest in the business if the owner dies or becomes disabled. Typically, the buy-sell agreement will include language that lets the company purchase life or disability insurance on all of the owners to ensure sufficient cash to fund a company purchase. However, many companies don’t get around to buying the appropriate insurance policies, or they don’t update the value of the company regularly to know how much insurance is needed. In situations where an owner dies or becomes disabled, an unfunded buy-sell agreement isn’t much better than no buy-sell agreement at all.
Once an owner has thought through the reasons that he or she wants to sell a business, it may be worth considering alternatives to an outright sale. Perhaps the owner wants to retain some degree of control or current income, in which case, hiring an interim CEO or manager, or transferring part but not all of the business may be an option.
Doing so means cutting into the owner’s income, because he or she will need to pay whoever steps in to take over those responsibilities, but it also allows for at least a tentative exploration of life outside of the business without making an irrevocable decision to leave. And it also leaves open the possibility of a future sale if you have shown that the business can operate without the owner’s day-to-day involvement.
Another less-happy possibility is that there is no realistic prospect for a sale. That might be because there is no ready, willing, and able buyer, or because there is limited value to the business after the owner leaves. For example, a service business with no long term or recurring contracts may not be worth much, even if the owner has spent years developing a list of clients. Or if the current owner represents the “brand” then it may be difficult for a new owner to maintain client relationships that have been built over a long period of time.
In such a case, shutting the doors could be the only option. This may mean a “fire sale” of remaining assets, such as inventory and equipment, but this is not a retirement nest egg in the making.
For owners with more time, it’s possible to increase the marketability of the business by cleaning up the financials, establishing renewable income streams, and diversifying the product or customer base. Above all, it is critical to make the business less dependent on the owner. This might mean developing a new management team or getting other employees involved in customer retention and business development.
Could you sell your business today? If not, it’s time to think about how to make it marketable.
When discussing a possible sale of a business, it’s important to talk with the right people and surround yourself with a supportive team. Many business owners first talk with their families, especially if the sale is part of retirement plans, if family members are employed by the business, or if a sale will result in the owner spending more time at home. Other likely suspects for pre-sale conversations include CPAs, business brokers, business appraisers, business attorneys, financial advisors, and estate planning attorneys.
Assuming that selling the business is still the best strategy, there are lots of ways to structure the transaction. Well-thought-out plans will take into account the tax consequences as well as the possibility of a company being sold to an insider, or passed on to a family member who has been involved with the business, or it might be marketed to third parties, such as competitors or “strategic” investors.
More complicated transactions include an initial public offering (IPO), which is when a private company goes public and its shares are traded on a stock exchange, and employee stock ownership plans (ESOP), which transfer a company’s stock to its employees. We’ll explore each of these concepts in more detail later. Stay tuned.
Whenever you begin to think about selling a business, it’s important to figure out why you want to sell. That might mean getting a pile of money, freeing up time, or finding something more interesting to do. Understanding the “why” can help you make better strategic decisions regarding how to structure the sale.
Sometimes the answer is obvious. If you’ve been running the same business for 30 years, or if health- or age-related limitations make it harder to keep up with business demands, then retirement may be a big motivation. If so, your goals likely will be to maximize the value of the business – which may take several years of pre-sale planning – and to minimize the amount of seller financing to ensure a secure source of retirement assets.
But retirement is not the only scenario prompting a business sale. Some owners experience friction with a partner and don’t want to continue working together. Others get bored and want to start a new venture. That’s often the case with “serial” entrepreneurs, who move from one business to the next. And some owners simply want more free time to spend with families or pursue other activities such as extended travel or community service.
Regardless of your particular reason, it’s important for a seller to be able to present a plausible explanation when marketing the business to prospective buyers. Buyers want to perceive value in the business they are spending good money to acquire. It’s not too early to begin thinking about your reason(s) for a sale.
Business owners often underestimate the emotional as well as financial ties connecting them to their business. For many owners, the business is their identity. If that’s the case, planning a new life after the business may be as important as planning the sale itself. Some questions to ask yourself:
• What will you do with all your time that was previously spent at work?
• Do you have hobbies or travel plans?
• Is there a volunteer organization that needs your skills?
• Are you going to start a brand new business?
• And will you have enough money to live on?
When selling a business, timing is everything. Ideally, you will sell when the business is healthy and growing. An owner who can’t let go may miss selling opportunities due to changing market conditions. Or he or she may lose focus and allow the business to decline, thus reducing its value. Do you have enough drive to continue building your business, or at least maintain it at current levels?
Financial considerations also can get in the way. Many sellers don’t have other sources of potential retirement income outside of the business. And if other family members are part of the business, a seller may postpone sale plans to maintain a steady paycheck for those family members.
Prioritize which items are most important in the sale. Is it maximizing immediate cash? Ensuring a stream of income over time? Providing continued employment or transition for key employees? Every sale involves negotiation, so identify what’s critical and build your strategy to obtain those results.