Owners of small businesses enter into buy/sell agreements with their partners to protect their interests in their largest investment, their business. The presence of such an agreement is essential to ensure a clean succession and to protect heirs. We applaud the efforts, but not always the process or results.
Much time is spent agonizing over details. Elaborate definitions of earnings are created; multipliers are agreed upon; the requirement for discounting is debated. All these factors, and others, are agonized over. Countless hours spent and professional fees incurred to arrive at a plan deemed acceptable to all, a daunting task.
Creating a hard-and-fast formula for a buyout can be a mistake. Businesses evolve. Products change, services are added or deleted. The nature of the business itself can change.
The lifetime of a small business can span many years or even several decades. The nature of our economy, and our society, has changed significantly over these periods. Not long ago, a garment manufacturer designed, manufactured and distributed their products from their own facility in the U.S. Today, they are, in essence, distributors. While they design and distribute, manufacturing takes place overseas. With smaller companies, these contract manufacturers are not captive to them, adding a layer of complexity and cost.
Industries have changed in other ways. SEC regulation of hedge funds, the emergence and disappearance of Blockbuster in a matter of a few decades are milestone changes in industries that just recently started. The onslaught of iTunes, Spotify and Pandora in the music industry has led to the virtual end of sales of albums. Uber threatens to end the taxi and limo industry as we know it. Just two examples of major upheavals in traditional industries we never considered would change. Formulas set even just a few years ago may no longer be relevant.
A better and more cost-effective solution for a buy/sell is to appoint a valuation firm to handle the project. A baseline valuation is performed which is then updated every one, two or three years. In some cases, no update to the baseline valuation occurs until a triggering event happens. In either case, appointing a firm that all partners agree to can avoid dissension at a critical and often emotional time.
Designing a buy/sell should be an integral part of an operating agreement. An attorney and a tax specialist ought to be consulted.
At JBV, we are here to assist you.