Over the years I have heard many business lawyers (myself included), tell clients that there are certain agreements that once signed, can be placed in a drawer and do not need to be reviewed until the particular event that is the subject of the agreement occurs. If you are an owner of a business and have a buy‑sell agreement in place, although you may think it does not need to be reviewed, much like each presidential candidate told the other at the recent debate, “you are wrong”. Your buy- sell agreement should be reviewed on at least an annual basis.
A buy‑sell agreement is an agreement between owners of a business entity (i.e. shareholders, members etc.) that sets forth the terms and the process to be followed when one of the owners desires/needs to sell his or her interest in the entity. A buy-sell agreement can be a stand-alone agreement and it can also be incorporated in another document (like an operating agreement or a shareholders’ agreement). These agreements usually come into effect upon the death or disability of one of the owners or in the situation where one of the owners wants to sell his or her interest in the entity to a third party.
For many, the buy‑sell agreement was entered into when the business started. In many situations, the circumstances of the business when it began are much different years later and the terms in the original buy-sell agreement are either outdated or do not fit the practical reality of the business currently. What seemed like a good plan years ago, may not be so today.
There are many specific provisions of a buy-sell agreement that should be reviewed from time to time. Just to mention a few: first, some buy-sell agreements only address the situation where an owner dies or becomes disabled and do not contain a provision to address the sale of an interest while the owners are alive and not disabled. Another provision to be reviewed is the method used to establish the value of the interest being purchased. Often, the provision used to value the interests is based on some pre‑agreed formula, or some multiple times earnings, or by agreement of the parties or by hiring an appraiser. Many agreements contain a valuation provision that is based on a valuation that is supposed to be reviewed on an annual basis. Again, what made sense when the business started may not make sense now. For instance, the multiple of earnings that is in the agreement which was applicable at the time the buy-sell agreement was signed may not be the multiple commonly used to value your particular business today. Also, agreements that have an annual valuation provision are often times ignored by busy business owners.
Lastly, an issue that should often be reviewed is whether or not the amount of insurance in place, if insurance is used to fund the possible purchase of the interests, is sufficient to pay the purchase price for those interests. If the value of the interests goes up (which most people want) the amount of the insurance may need to increase also.
The key to remember is that you need to review your buy-sell agreement. For many business owners the ownership interest they have in their business represents a significant portion of their wealth and the value that will be created from the sale of their interests could be considerable.