When a group of people start, inherit or otherwise co-own a business together (like a traditional business, commercial building or farm), the operation will likely have more value as a collection of assets, opportunities and people (synergy) than the sum of the components separately.
Nevertheless, in time, some co-owners may seek to leave operation, some co-owners will pass away and some co-owners will desire to own more of the operation.
A good buy-sell agreement can transform a regular business into a multi-generational legacy that maximizes each co-owner’s value and opportunity.
Despite our idyllic dreams that everything that is good will remain the same, the world changes, people change, people move and people pass away. A buy-sell agreement needs to be clear as to what triggers a buy-sell transaction, who has the power to exercise that trigger, how much money the buyout will cost or generate.
Specifically, an effective buy-sell agreement will include the following four components:
-First, departing co-owners must expect that they will not get “top-dollar” for the portion of the business with which the departing co-owners are parting.
Notably, a co-owner of a business does not own a portion of the assets in a business. Instead, a co-owner of a business owns part of a synergistic operation. Thus, a part of a synergistic operation — which is not necessarily marketable and does not include control of the whole operation — is less valuable than a portion of the assets of the operation.
Thus, in valuing business co-ownership, a discount for lack of marketability and lack of control is appropriate.
-Second, departing co-owners must understand that there will necessarily be limits on how many people can leave the operation at one time.
For example, if a family of 33 cousins co-own a business, the business is likely to fall apart for all practical purposes if 11 of the 33 co-owners depart the business at one time.
-Third, departing co-owners must agree to accept some buy-out payments over time. Selling co-owners who take payments over time ensure the business’s financial stability. The business may be able to avoid installments through a direct payment or via a loan from a separate lender, but departing co-owners need to be ready to accept at least some installment payments.
-Fourth, co-owners of the operation who remain in the operation must agree that the discounts and installment payment benefits will not personally benefit them.
In other words, if a departing co-owner is required to sell his or her co-ownership at 70% of fair market value (as explained above), the operation and its remaining co-owners should agree that if those people remaining in the business later (within a set number of years) sell the operation as a whole for 100% or 120% of its fair market value, the remaining co-owners will reconcile or settle up with the co-owners who sold earlier at a discount.
Business succession planning is individualized, complex work. Buy-sell agreements with these crucial components stand the best chance of supporting mutual, multi-generational success for all co-owners and the business itself.
Lee R. Schroeder is an Ohio licensed attorney at Schroeder Law LLC in Putnam County. He limits his practice to business, real estate, estate planning and agriculture issues in northwest Ohio. He can be reached at [email protected] or at 419-659-2058. This article is not intended to serve as legal advice, and specific advice should be sought from the licensed attorney of your choice based upon the specific facts and circumstances that you face.
