Be prepared to deal with a potential buy-sell ‘trigger event’
Millions of people are invested in public stocks, and they typically have a few things in common. Most have no control over company decisions (hiring, firing, operations, policy, etc.). However, their shares have marketability at virtually any time of day, any day of the week. The same is not true of private, closely held companies. There are many types of multiple ownerships in closely held businesses, (partnerships, corporations, limited-liability companies, etc.) but whatever you call them, they are marriages of one sort or another.
Marriages are intended to last until eternity, but many don’t. Many end up in divorce.
And the same is true of many multiple-owner businesses. For all practical purposes, a business with multiple owners is a partnership, regardless of the ownership entity. So for our discussion, let’s address a 50-50 partnership, a very common entity. Typically, in a 50-50 partnership, there are two minority owners. Unless there are other contractual arrangements, neither partner has control. A lack of control usually creates issues of the marketability.
Most closely held businesses or professional practices with multiple owners will, sooner or later, experience a “trigger event,” and all owners should be prepared. A good way is to have a carefully prepared buy-sell agreement.
What are “trigger events”?
Death of an owner. No one lives forever. Sooner or later an owner will die. His or her interest will need to be addressed (bought out, sold, or with a new partner such as the surviving spouse).
Retirement: No one works forever. Sooner or later a living partner will want to retire. That interest will need to be dealt with.
Fired: Not all marriages or partnerships work out. It may be easier to get rid of a spouse than to get rid of a partner.
Disabled: A working owner cannot participate in a manner required due to an injury or illness. There must be a way to equitably remove him or her from the position.
Litigation: You partner is stealing, has been arrested, or perhaps is involved in some litigation that could reflect badly on the business. It could also be a divorce whereby you would end up with a spouse as a partner.
I experienced a phone call from an attorney wanting a valuation on a 30 percent interest for a retiring owner in a closely held business. The buy-sell agreement said “the minority interest shall be valued at fair market value without discount.” That statement was a contradiction in definitions and the owners are headed for court.
The generally accepted definition of fair market value is: “The price that a hypothetical, willing buyer would pay, that a hypothetical willing seller would accept, all parties being in possession of the relevant facts, with no one compelled to act, and the business having been exposed to the market place for a reasonable period of time.”
The key word is “willing.”
Suppose a 30 percent owner says to his co-owner, “I want out, so buy me out.” Co-owner says, “Go out into the world, find a buyer, then come back to me and I’ll pay you fair market value.”
Is this a willing seller? Is this a willing buyer? The answer to both is yes. Therefore a standard of fair market value could apply.
A majority owner says to 30 percent owner, “I want you out, and our agreement says you must sell out to me.”
Is this a willing seller? Maybe not, so the standard of fair market value may not apply. Many buyers would not even consider buying a non-controlling interest in a smaller business, even with discounts.
So the question arises: How do you remedy such a situation? The answer is that a properly prepared buy-sell Agreement should cover those events. Unfortunately, many attorneys prepare buy-sell agreements from Boiler Plate that rarely address real life issues, including:
What standard of value should be used in valuing the interest of the departing or departed owner (fair market value, fair value, investment value)?
What shall be the “effective date of valuation?” (date of departure, end of fiscal period)?
Who shall perform the valuation (certified appraiser, bookkeeper, next-door neighbor)?
What qualifications such as certifications or experience shall the appraiser have?
What financial data shall the appraiser rely on (tax returns, in-house generated financials?).
Whose professional appraisal performance standards shall be followed?
Who shall pay the appraiser?
Who will fund the buy-out and how will it be funded (insurance, stock, cash from the business)?
If a party disagrees with the valuation, what are the remedies?
Who should prepare the buy-sell agreement? Certainly, an attorney who is familiar with the nuances of such agreements.
Jerry F. Golanty is a Reno-based Master Certified Business Appraiser and Certified Financial Forensic Analyst. Contact him at firstname.lastname@example.org.
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