Will Your Buy-Sell Agreement Solve Problems or Cause Problems?
One of the most important planning documents for a business with multiple owners is a well-designed buy-sell agreement.
A buy-sell agreement provides a roadmap for what happens when ownership needs to change hands. Whether the trigger is death, disability, retirement, divorce, bankruptcy, or an unexpected departure, the agreement establishes how ownership interests will be valued, transferred, and funded.
When thoughtfully designed, a buy-sell agreement can reduce uncertainty, preserve relationships, and provide clarity during some of the most emotional and challenging moments a business and its owners may face.
Unfortunately, simply having a buy-sell agreement does not guarantee a positive outcome.
In many cases, buy-sell agreements create as many problems as they solve. Agreements that are outdated, incomplete, overly simplistic, or poorly implemented often leave owners and their families facing difficult decisions precisely when they hoped those decisions had already been made.
A Few Important Questions
Do you need a buy-sell agreement, and if so, do you have one?
When was the last time your agreement was reviewed?
Does it still reflect the goals of the owners and the realities of the business today?
If a triggering event occurred tomorrow, would the agreement reduce conflict or create more of it?
These are important questions because many buy-sell agreements contain significant planning gaps.
Common Buy-Sell Agreement Mistakes
Ignoring Lifetime Triggering Events
Many agreements focus exclusively on death or permanent disability. While those events certainly matter, they are often not the events most likely to occur.
What happens if an owner:
Gets divorced?
Files for bankruptcy?
Wants to retire earlier than expected?
Voluntarily leaves the business?
Must be involuntarily removed?
Without clear provisions addressing these situations, owners can find themselves navigating difficult circumstances without a roadmap.
Using an Inadequate Valuation Method
Business value changes over time.
An agreement that relies on an outdated fixed price or a simplistic formula may produce results that are unfair to one or more parties. The valuation method should reflect the complexity, growth, and changing dynamics of the business.
Questions that should be answered include:
What standard of value will be used?
Will the agreement require a formal valuation?
Will the entire company be valued or only the ownership interest being transferred?
What discounts or premiums, if any, will apply?
Failing to Address Timing
Valuation is not only about methodology. Timing matters as well.
Will value be determined as of the date of the triggering event? Six months later? At closing?
Different timing provisions can produce significantly different outcomes, particularly during periods of rapid growth or economic uncertainty.
Failing to Address Funding
A buy-sell agreement is only as effective as the funding behind it.
Many agreements clearly describe how ownership will transfer but provide little guidance regarding how the purchase will actually be paid for.
Common funding methods include:
Cash: Requires substantial liquidity or cash reserves.
Bank Financing: Depends on future borrowing capacity and lender willingness.
Installment Payments: Relies on future business performance and cash flow.
Insurance: Often provides immediate liquidity in the event of death or disability.
The funding method should be carefully coordinated with the valuation provisions and the financial realities of the business.
Protecting Business Continuity
One of the most overlooked weaknesses in many buy-sell agreements is their failure to address business continuity.
The agreement may successfully transfer ownership, but can the business survive afterward?
Consider a few common scenarios:
The deceased owner was the primary rainmaker.
The departing owner served as the company's COO.
Personal guarantees supporting key financing disappear.
Critical customer relationships are concentrated with one owner.
A successful ownership transition requires more than transferring stock or membership units. It requires a plan for preserving the value of the business after the transition occurs.
Protecting the Owner's Family
Buy-sell agreements should not only protect the business and surviving owners.
They should also help protect the financial security of the departing owner's family.
If an owner dies unexpectedly, what outcome does that owner want for their spouse and children?
Will they receive fair value?
Will they receive liquidity when needed?
Will payments be dependable?
Will the family be forced to remain financially tied to a business they do not control?
These questions deserve thoughtful consideration long before a triggering event occurs.
Questions Every Buy-Sell Agreement Should Answer
A well-designed agreement should provide clarity regarding:
Lifetime triggering events, including divorce, bankruptcy, voluntary exit, and involuntary termination.
The valuation standard and methodology.
The timing of valuation.
Whether the entire business or only a partial ownership interest will be valued.
The funding source for the transaction.
Whether a purchase is mandatory or optional.
The rights and obligations of all parties involved.
The desired outcomes for the owner's spouse, family, and estate.
Final Thoughts
A buy-sell agreement is much more than a legal document.
At its best, it is a risk-management tool, a business continuity tool, and a family protection tool.
If your agreement has not been reviewed in several years, there is a good chance it no longer reflects the current value of your business, the goals of the owners, or the realities your family would face if something unexpected happened.
The question is not whether you have a buy-sell agreement.
The more important question is whether your buy-sell agreement will solve problems—or create them—when it is finally needed.
Buy-Sell Agreement Review: if your agreement is more than three years old, ownership has changed, business value has increased significantly, family circumstances have changed, or funding arrangements have not been reviewed recently, it may be time for an update. Contact us a email@ennislp.com or 301-859-0860 for assistance.
