The Many Flavors of Buy/Sell Agreements – Each with Their Own Time Bomb
By Nina Kaufman, Esq.Here’s one last issue that Chris Mercer raised in his Buy/Sell Agreements book that I want to share with you. Once you have (1) decided when an event triggers a buyout, and (2) computed how you’ll fund the purchase, you need to determine who gets to make the purchase and how you’ll come up with the buyout amount.
As to who get to purchase, buy/sell agreement fall into three main categories, just as Baskin Robbins ice cream has single flavors (chocolate), mixed flavors (Gold Medal Ribbon (R)), and textured (ah, Rocky Road). There are:
- Cross-purchase agreements. The business owners will take the responsibility to buy the ownership interests from each other when the trigger event occurs.
- Entity-purchase agreements. The company buys the interest back from the owners.
- Hybrid agreements. The company gets first dibs at the ownership interest but if it refuses, the remaining owners get the opportunity to acquire the departing interest.
How much will you pay for the interest? Well, to take the poet, Elizabeth Barrett Browning, out of context, “Let me count the ways”:
- You could agree on a fixed price. Problem is, the price you establish at the inception may not be fair 10 years down the road.
- You could develop a formula, such as a multiple of earnings. But you need to be sure the formula makes sense for your industry.
- You could go to an appraiser (or appraisers) and let her figure it out. However, who will choose the appraiser? Will they be biased toward one side or another? If you get multiple appraisers, those professional fees can mount quickly.
- You could take a shotgun approach. No, I’m not advocating Winchester or Smith & Wesson. 🙂 Under this approach, you name your price, and the other owner can choose to buy you out, or be bought out at that price. Set the price too low, and you’ll get very little. Set the price too high, and your former partner will be basking in Bora Bora before you can say “blindsided.”
Do you see how much is involved in putting together a buy/sell ownership agreement properly? That, my friends, is why these kinds of agreements aren’t “one-pagers.”
For more details and a further discussion of the pros and cons to the kinds of agreements and ways to calculate the valuation, get the book, Buy/Sell Agreements, and read it for yourself!
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