Top 10 Mistakes in Buy/Sell Agreements
The buy-sell agreement arguably is the most important legal agreement for closely-held entities. The items listed below are common errors we see in these agreements, or items often not addressed. For a more detailed discussion, attend our “Understanding Buy/Sell Agreements” Workshop, where you can learn much more about opportunities as well or pitfalls in Buy/Sells.
1. Failure to Coordinate. It is important to review governance documents, such as articles of incorporation/organization, bylaws/operating agreements, and loan documents or other significant contracts, to determine how they affect the buy/sell agreement, or vice versa.
2. Improper Selection of Type of Buy-Sell Agreement. Selection of the wrong type of agreement can create unintended and unwanted results. Consider the various scenarios under the agreement to make sure that the parties’ real desires are carried out.
3. Improper Selection of Triggering Events. If the buy-sell agreement doesn’t cover a particular event, the owner or the entity may have no rights in such a situation. Consider the possible applicability of triggering events beyond death and disability. For example, what if one owner loses a professional license or is no longer qualified as an employee or becomes divorced or bankrupt?
4. Rights and Obligations Following Occurrence of a Triggering Event. The consequences of a triggering event can be no action at all, mere notice or mandatory liquidation-and all points in between! Take care to track through the rights and obligations for each triggering event to make sure that the rights and obligations for each party are appropriate.
5. Valuation Issues. The uncertainty of future value often seems to make clients minimize the importance of the valuation of a business interest in the event of the exercise of a purchase right or sale right. Be sure to ascertain the standard and level of value for the interests. If a formula is used, understand the formula’s basis, play out the scenarios, and try to develop a backup method.
6. Funding Issues. Parties must consider payment sources while they are putting together a buy-sell agreement. An unfunded buy-sell agreement may be a bigger problem than no buy-sell agreement at all. Make sure the owners have identified funding sources and that those sources, such as life insurance, are properly aligned with the people who will be entitled/obligated to purchase.
7. Financing Terms. Many buy-sell agreements contain installment payout plans for payments of purchase price that exceed life insurance. In determining the details and flexibility of installment payments, pay close attention to the size of the projected installment payout relative to the amount of the currently available cash flow from the person who is entitled/obligated to purchase.
8. Failure to Coordinate Related Properties. Sometimes the business is dependent on related properties not owned by the business. Related property can include life insurance polices on the life of the selling owner, interests in land (such as property on which a business operates), intellectual property, leases or other contractual obligations. It is important to analyze the subject company to see if it is reliant upon property that is owned by others and the terms of those arrangements.
9. Failure to Put it All Together. Many, if not all, of the preceding points are interrelated. For example, selection of a triggering event must be carefully coordinated with the rights and obligations that are triggered by that event. Those rights and obligations must in turn be carefully coordinated with the terms of installment payout for any purchased interest. Don’t neglect to look over the document as a whole and coordinate it with each owner’s objectives and personal estate plans.
10. Using a “Standard Form”. Buy-sell considerations differ from business to business and even from owner to owner within each business. Be sure the agreement reflects those unique circumstances