Your business or practice is going strong. You are making a comfortable living. When was the last time that you thought about what would happen to the business when you are no longer running it. Whenever you get into a business, one of the most important items that you should consider is how to get out of the business. This is called an exit strategy.
This could be in the near future, such as with an unexpected disability or death. It could be many, many years down the road when you are considering retirement. Do you have family or key employees to run the company until it can be sold or closed down? Are you grooming someone to take over and buy the company?
Do not wait until you are in your seventies and your kids are in their fifties to sell them the business. I have seen this happen. At that stage in their lives, the kids may not want to go into debt for ten or more years to buy the business and when the business is finally paid off, they then would have to find a buyer for the company before they can retire.
When you have co-owners in the business, the exit strategy should be documented in a comprehensive buy/sell agreement. The buy/sell agreement documents the procedures to follow when co-owners no longer will be working together, be it through retirement, death, disability or otherwise.
The buy/sell agreement should include all of the events which could trigger the buy/sell transaction. Some events which trigger the buy/sell provisions are when one of the co-owners retires, becomes disabled, no longer works full-time, dies, wants out, wants another owner out or if the owners just can no longer get along. Other reasons that could trigger the provisions of a buy/sell agreement are divorce, insolvency, bankruptcy, an owner lawsuit or the failure of an owner to make a capital contribution.
It should be clear in your buy/sell agreement at which price the selling owner will sell his or her ownership interest in the business. You may want to use a stated value to which the co-owners agree on an annual basis. A formula value based upon sales, income or other factors is another option. Book value of assets is occasionally used for sales upon certain triggering events. You may prefer that the selling price be determined by an appraiser or appraisers.
When you have a buy/sell agreement, it is important that the purchaser be able to fund the purchase. This is frequently accomplished with life insurance. Seller financing is sometimes used. In other instances, bank financing may be able to be utilized. A buy/sell agreement is very little protection if you are unable to finance the purchase.
The buy/sell agreement should document who is going to purchase the ownership interest of the seller. The company can be the buyer or the other owner(s) can be the buyer(s).
You may be tempted to just put a few pages of buy/sell provisions into your limited liability company operating agreement or corporate bylaws thinking you will have adequate buy/sell protection. Unfortunately these limited provisions do not cover all of the situations that could arise between business owners. Inevitably, you end up in a situation not contemplated in those few pages. I have seen this happen time and again. And guess where you end up? Usually in court.
A comprehensive buy/sell agreement is often longer than the bylaws or operating agreement themselves. The legal fees to prepare such a buy/sell agreement usually cost more than to set up the corporation or limited liability company in the first place.
If you have partners, the initial cost should not stop you from obtaining a comprehensive buy/sell agreement. I see situations on regularly basis where partners did not enter into a comprehensive buy/sell agreement when the business was started. Then years later one of the owners wants out, or one or moe of the owners want another owner out
Then it is oftentimes too late. At that point, you have nothing documented to govern the buy-out. And since the owners cannot agree, you usually have only one option, court proceedings at a cost of tens of thousands of dollars in legal fees for each party.
.The cost of these court proceedings are substantially more than what it would have cost to set up a proper buy/sell agreement at the outset. Remember the old Fram oil filter commercial, you can pay me now or pay me a lot more later.
By: Matthew M. Wallace, CPA, JD
Published edited January-February 2013 in Savvy magazine as: Business exit strategies are critical