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. What will happen when you no longer are running your business?
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. The kids may not want to go into debt for ten or more years knowing that they will then 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 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 their 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 fund 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.
You may be tempted to just put a few paragraphs 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 paragraphs.
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 buy/sell agreement. All too often, if you put off your buy/sell agreement when you start your business, you do not think about it again until you and your partners are no longer getting along and one owner wants out. Then it is often times 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. 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 March 22, 2009 in The Times Herald newspaper, Port Huron, Michigan as: In business, exit strategies are key