Dec 29, 2015, 7:16am EST
As a Baltimore business owner, you are part of a long tradition of home-grown success stories.
As a Baltimore business owner, you are part of a long tradition of home-grown success stories.
Consider McCormick & Co. Inc., which started out in Baltimore in 1889 when founder Willoughby McCormick began selling flavors and extracts door to door.
Perhaps your personal and financial goals are to establish a legacy as long asWilloughby McCormick’s. More likely, your goals may be to fund a comfortable retirement, and perhaps leave a legacy for your children.
In any case, if you are counting on your ownership interest in your closely held business to help meet your goals, you would be well advised to consider adopting a buy-sell agreement or BSA for your business in order to preserve the business’ viability.
The agreements prevent control from passing to unwelcome and potentially disruptive parties. They also help make sure you — or your estate— receive a fair price for your interest in the business on your retirement or death.
As time goes by, one of the most fundamental threats to preserving a closely held business’s value is the risk of ownership interests passing to individuals who will disrupt the smooth operation of the business. By way of example, following the death of an owner, his or her children might acquire an ownership interest through inheritance.
Should some of those children elect not to take an active role in the business, there may be clashes among the resulting owners on issues where their respective interests are not aligned, such as whether to distribute or reinvest profits. Needless to say, this type of turmoil can have a corrosive effect on the ongoing viability and value of a business.
Your business' buy-sell agreement could mitigate this risk by placing restrictions on transfers of ownership interests. These restrictions typically take the form of “rights of first refusal” given to the business, or current owners, to purchase the interest of a withdrawing or deceased owner at an established price. Where the rights are given to current owners, they may be allocated equally or tailored to specific situations.
Rights of first refusal are very useful to preserve your business’s ongoing viability, but they do not require anyone to purchase your ownership interest upon your death or retirement. This leaves open the additional risk that upon your death your estate will be forced to either negotiate a sale of your ownership interest from a position of weakness, or postpone any sale and risk a liquidity crisis when estate taxes become due and/or your surviving family members require funds for their support. This could severely reduce the value of your legacy to your family.
Your BSA could mitigate this risk as well, by empowering you to negotiate in advance the price that will be paid for your interest upon your retirement or death and imposing a mandatory purchase obligation on the business, or remaining owners, to buy your interest at the established price.
By establishing who will buy a withdrawing or deceased owned interest well in advance of a purchase, your business’ BSA could have the added benefit of giving the designated buyer time to plan how to fund the purchase. A common funding strategy is for the designated buyer to purchase life insurance on each owner, and upon the death of an owner use the insurance proceeds to purchase the deceased owner’s interest.
This approach is particularly appropriate where it is uncertain whether the buyer will have sufficient funds to purchase a deceased owner’s interest. Your advisers can help determine who should be the designated buyer under your BSA and the funding option that is most advantageous for you.
Your advisers should also help you select the method for determining the purchase price of a withdrawing owner’s share — a critically important question. A simple approach is to set a fixed price with provisions for periodic price renegotiation, since the value of the business is likely to change over time. But watch out: you may neglect to renegotiate the price until a buyout is triggered.
At this point, your bargaining leverage may be weak, resulting in a lower renegotiated purchase price than the interest’s value. Another option is a buy-out formula tied to a financial measure, such as your business’ book value, net earnings, or cash flow. Whether any of these financial measures constitutes an appropriate price setting approach depends on the circumstances and nature of your business.
While setting a fixed price or utilizing a financial measure has the benefit of expediency, your BSA could alternatively call for engaging a professional appraiser. This can provide a greater degree of comfort that the purchase price reflects current market conditions. Under this approach, your BSA could specify the minimum credentials for an appraiser and how the appraiser will be selected.
By protecting against loss of control of your business to outsiders and setting a fair price for each withdrawing owner’s interest, your business’ BSA could help to preserve the value of your hard-earned investment, which will be critical for maintaining your quality of life in retirement and protecting your financial legacy for your family. Note that any strategy should be based on the business owner’s objectives, and services of professional advisers should be sought.
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For additional information regarding Florida business sales, acquisitions and valuations, please contact Eric J. Gall at Eric@EdisonAvenue.com or 239.738.6227. Also, visit our Edison Avenue website at www.EdisonAvenue.com or my personal website at www.BuySellFLbiz.com.
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