When Exit Planning Advisors ask business owners what kind of business continuity plans they have in place, the typical response, if they have any at all, is usually along the lines of, “we already have a Buy-Sell Agreement.”
To the business owner, this agreement checks “solve business continuity problems” off the to-do list. However, Exit Planning Advisors know that oftentimes these agreements create more problems than they solve. A typical Buy-Sell Agreement has gaps that need to be addressed at any given time, which is why it is important that they are not seen as the “quick fix” to business continuity.
In order to debunk this idea from the perspective of the business owner, Exit Planning Advisors should know the key factors that make up a good Buy-Sell Agreement:
Current & updated
Considers correct business value
Protects the business & the family.
Current & Updated Buy-Sell Agreement
Buy-Sell Agreements may not have sell-by dates, but they should. When they are filed away and go un-reviewed in the context of business circumstances and changing desires of business owners, much can go wrong, especially in emotionally charged situations. It is critical that these agreements reflect the realistic goals and resources of the business and owner(s).
BEI suggests that Exit Planning Advisors review these agreements with owners on an annual basis as part of the fiscal year review. Looking at the Buy-Sell Agreement each year can account for the following changes and key items to include:
An increase or decrease in transferable business value
New ownership or management and their voting control
Owner’s exit goals given changing economic or family circumstances
Events that are covered by the Agreement
Instructions on how future buyouts will be calculated
How to fund different types of buyouts
Considers Correct Business Value
While it is important to review the Buy-Sell frequently, it is also crucial to understand that even when considering various business aspects, Buy-Sell Agreements still fall short of covering all the complexities of a business valuation. Many Buy-Sell Agreements have too simple of a valuation methodology, which can be due to inadequate adjustments that account for business growth, or inaccurate estimates from the owner(s).
For this reason, BEI suggests having a third-party appraiser determine business value to be referenced in this Agreement. Using outside experts will ensure the valuation is objective and accurate. As an Exit Planning Advisor, every arrangement should begin with an understanding of the owner’s lifetime exit goals and aspirations, as well as the existing resources. This understanding, especially if revealed using tools like that of BEI’s EPIC planning software, will show you and your owner clients if there is an existing gap between the current resources and what is needed to close it.
Working with owners and their advisor teams to find clarity on these goals, resources and business value will allow for inclusion of these items within the Buy-Sell Agreement and other business continuity efforts.
Protect the Business and the Family After Selling
An effective Buy-Sell Agreement must have structures in place to protect the business and all owners in the case of sudden death or incapacitation. Making financial security for the family a priority as well as having sufficient life insurance policies in place are ways that the Buy-Sell Agreement could provide protection.
Most Buy-Sell Agreements focus on the benefits to the surviving owner rather than providing for the needs of the decedent's family. The question that advisors must ask and help owners resolve is, “If you die, what will replace your income stream for your family?” There are many answers to this question that may lead to the restructuring of the Buy-Sell Agreement so that the descendant's family is supported at the same level of their loved one’s lifetime income. To ensure this, it would be wise to include clauses in the agreement to cover continued income streams and ownership since proceeds from the Buy-Sell are rarely enough.
In addition, Buy-Sell Agreements should map out how each particular type of buyout would be funded. For example, if there is a life insurance funding a buyout of a deceased owner, is it a sufficient amount? Is the policy owned by the proper party, and are the beneficiary designations correct? In all buyout situations, it is important to at least have some pre-funding and have the Agreement designed to minimize taxes.
Lastly, it is worth noting that often a business exit is triggered by another lifetime event aside from a death, such as owner’s incapacitation, divorce, bankruptcy, termination, and other disputes. While a Buy-Sell Agreement cannot cover all these transfer paths, advisors must encourage owners to consider these factors so the business does not suffer any severe consequences.
Conclusion & Takeaways for Exit Planning Advisors:
It’s important to reiterate that even with the most current, well-thought-out Buy-Sell Agreement, this document is not the comprehensive solution to business continuity. It is not everything, but it can be a vital component of continuity planning if Exit Planning Advisors can work with business owners to:
Review the Buy-Sell Agreement annually to update and modify any changes or additions to business variables.
Ensure the Buy-Sell Agreement reflects an accurate and realistic business valuation, determined by a third party.
Determine how to increase business value based on the gaps that are brought to light by the valuation and desired exit goals.
Take measures that will protect the family’s financial security.
Check out a recent webinar recording on Buy-Sell Agreements, lead by BEI Founder, John Brown.
Ready to get started? Schedule a meeting with us today to discuss the components of business continuity and your role as an Exit Planning Advisor.