Thinking About Selling Your Business? Don’t Wait to Fix Your Buy-Sell Agreement

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Are you thinking about selling your business at some point?  Are your clients thinking about selling their businesses someday?

If a sale in the foreseeable future is a possibility, should you bother to be sure that your buy-sell agreement is in good working order? We will answer that question below.

When thinking about topics for the blog, sometimes its best to rely on the situations we face every day helping clients think through issues. However, sometimes clients simply tell us by the questions they ask or by what they ask us, as business appraisers and financial advisers, to do for them.  The following story represents a composite from three separate recent discussions with clients.

Either: Fix the Buy-Sell Agreement?

Recently, I was meeting with the owners of a business where the initial topic was a valuation for purposes of their buy-sell agreement.  The owners were not old, but neither were they young.  They had an exiting buy-sell agreement that they all agreed was inadequate.  The only trigger event in the agreement was the death of an owner.

I noted that given the three of them, death was the least likely major trigger event for the agreement, and they agreed.  We talked about disability, retirement, and a couple of other potential other trigger events that their agreement should cover.

As usual, I recommended that the owners agree on potential trigger events and then ask their corporate attorney to draft a buy-sell agreement with appropriate provisions.  I suggested that the best valuation mechanism would be for a qualified appraisal firm (i.e., Mercer Capital!) provide an initial appraisal for the agreement to set the initial price for future trigger events.  I call that a single appraiser, select now and value now kind of valuation process.

The standard of value for the appraisal I suggested was fair market value.  After some discussion, the owners agreed that the valuation should be at the financial control level of value, shown in the middle of the chart below.

Revised-Levels-of-Value-Chart

The group seemed to have achieved a consensus along this path, then…

Or: Investigate a Sale of the Business?

During the conversation, it became apparent that there was some thought on the part of one or more (perhaps all) shareholders to sell the business.  We then talked about that possibility at some length.

I noted that given the company was in an industry exhibiting some consolidation, there was at least a reasonable chance that the ultimate purchaser might be a strategic one, which would put value at the top level in the chart above.  Conceptually, there is a range of potential increase in value between financial control and strategic control.

I suggested that we could provide calculations regarding a reasonable range of value, including potential strategic value, with the analysis including the following:

  1. Base value at the financial control value
  2. Identification of excess or non-operating assets
  3. The reasonable potential for expense savings or other merger economies by likely acquirers
  4. The record of historical earnings growth and the outlook for future growth for the business
  5. The expected sustainability (or potential for deterioration) of margins as viewed by likely acquirers
  6. Perceived risks and benefits of the business from the perspective of likely acquirers
  7. Examination of likely acquirers based on conversations with management and independent research
  8. The perceived likelihood of identifying multiple strategic acquirers with interest in the business
  9. The willingness of existing management to remain with the business for a reasonable time following a sale
  10. Examination of available information on recent acquisitions of similar businesses

With a realistic assessment of potential strategic value in hand, the owners are in a much better position to think seriously – or not – about a potential sale of the business.

One of the owners then suggested that if they might consider a sale of the business, perhaps they should hold off on working on the buy-sell agreement.

Both: Fix the Buy-Sell Agreement and Investigate Potential Sale

Thinking about possibly selling a business and actually taking the steps necessary to do it are two different things.  Under good circumstances, it can take a year or more from reaching a final decision to actively pursue and achieve the sale.  Lots of things are causes of no transactions or delayed sales, including:

  1. The owners lose interest in selling or disagree on timing after initial decisions are apparently made
  2. Bad things happen to good companies.  If operating results falter during a sale process, buyers tend to increase skepticism and lower pricing
  3. No strategic buyers stepped up with interest
  4. There is a downturn in industry conditions that dampens interest of acquirers
  5. A recession occurs in the national economy, which lowers prices of potential acquirers and makes financing more difficult
  6. And on…

The point is – it is far better to fix the buy-sell agreement now, even if there are thoughts of a potential sale.  There is no reason for a business not to pursue two paths.  Both are good for the business.

First, it is always good to have a realistic idea of potential acquisition pricing.  If an unexpected offer comes along, it is far better to have a context within which to evaluate it, rather than scrambling at what would then be the last minute.

Next, it is always good to have a workable buy-sell agreement in place that the owners have agreed on.  Most sales that owners “think about” don’t occur but end up being fleeting thoughts.  Every business has an ongoing need for ownership succession protection provided by a buy-sell agreement.  It is far better to take care of long-term needs for the long term, and then, to investigate possibilities as they come along.

Concluding Thoughts

Based on my experience, many companies, like the company(ies) reflected in the story above, have a pressing (whether realized or not) need to update their buy-sell agreements.  Their owners may also have occasional thoughts regarding potential sales of their businesses.

If your business, or your clients’ businesses, have a dated, or known-to-be unreasonable buy-sell agreement, run, do not walk, to get the proper team together to update and upgrade the agreement.

It is far better to reach an agreement when all owners are in the here and now.  It is virtually impossible when one is in the hereafter, when the interests of his estate and the remaining owners have diverged.

And, if you want to think about a possible sale of your business, give us a call to talk about preparing a strategic value analysis like outlined above for your business.

The costs of fixing buy-sell agreements and investigating strategic options is nominal relative to the costs of potential litigation regarding buy-sell agreements or lost opportunities because of a lack of knowledge of market value in a sale context.

See this post on the One Percent Solution to put costs of managing the wealth in your business in perspective.

See also this offer for my two recent books (the Ownership Transition Bundle) that business owners and advisers are finding helpful.

Call if we can help you.  In the meantime,

Be well!

Chris

Reminder

My two most recent books are available in an Ownership Transition Bundle.  The bundle, priced at $35 plus s/h, has been attractive for many business owners, appraisers and attorneys.

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Please note: I reserve the right to delete comments that are offensive or off-topic.

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