Buy/sell agreements are useful business planning tools
By Greg Wolf
All planning involves uncertainty, and the first of any year is a pointed reminder of that. What lies ahead in this new year in terms of markets, weather and other factors in the business environment? Nobody knows, though we often make our best guesstimates. Furthermore, nobody really knows what might happen on the "inside" of a business either, even a business we know better than anyone else--our own. In both the external and internal business environments, there is a wide range of uncertainties--contingencies--that exist. But good business planning anticipates those uncertain developments, or contingencies, as well as possible, and puts in place processes for responding to them when and if they arrive.
One such tool used in business planning is a buy/sell agreement. A buy/sell is simply the documentation of terms for the transfer of a business or asset upon some triggering event. Standard triggering events include death or incapacitation, bankruptcy, divorce, and partner withdrawal. While this is a fairly objective list, the human dynamic involved makes for a wide, wide variety of emotional, challenging, and sometimes nearly debilitating circumstances. The key attribute of a buy/sell agreement is that it provides for terms and a process that have been agreed upon in advance, laying out a roadmap to respond to some triggering event, and allowing and assisting those involved to direct their emotions and attentions elsewhere. While not a substitute for open communication, and not an "end-all, be-all," a buy/sell agreement nevertheless has tremendous value in helping to assure business continuity, protect remaining partners, and maintain partner (often involving family) harmony in the event of a triggering event.
Buy/sells do not stand alone, but rather serve as one important element of a comprehensive planning process. Most large and complex agricultural operations consist of two distinct types of businesses that have different issues and therefore planning needs. One need is for the transfer of real assets and investments, commonly referred to as estate planning. The other is the need to plan for the continuation of the business operations themselves, commonly known as succession planning. The purposes and use of buy/sell agreement vary depending on its purpose and use.
In an estate planning situation, a buy/sell is used in the event that an heir (or in some cases a survivor) wants to liquidate. The agreement specifies the various triggering events that may require a liquidation, and determines who can purchase the assets, the process for setting the purchase price, and other terms of the purchase. In succession planning, a buy/sell is primarily used in the occurrence of a triggering event to compensate partners, spouses, or heirs. In addition to qualifying new partners, it also lays out the process for business valuation, lays out terms for a buyout, among other more specific provisions which can be included.
Buy/sell agreements lay out an objective basis for when the buy/sell itself is executed. Although the list of triggering events mentioned above is rather standard, it can help define exactly when the actual trigger occurs. In addition, they are an important tool in admitting new partners, and answer the question "Who can be a partner?" Specific qualifications can be documented--all agreed to in advance--including education, work experience, other subjective attributes such as willingness and work ethic, and the approval required of existing partners, whether by majority or unanimous agreement. Another important element often included is defining the rights of first refusal. This is where the buy/sell spells out the order in which the entity, remaining partners, or immediate family, for example, have the option to purchase. In a real estate entity, the first right of refusal to operate may be included, which provides a level of protection for the on-farm heirs for their ongoing operations. Buy/sells identify other buyout terms as well, including structure for payments, note terms, and interest rates.
Several options exist for business valuation, and having them defined in advance helps smooth a future transaction. Sometimes a valuation takes place upon the occurrence of a triggering event. However, depending on the nature of the event, this has potential for greater conflict, possibly even when the partner group was not aware of any conflict leading up to the triggering event. Questions around who will perform the valuation, and how values will be determined have potential to impassion a perhaps already emotional time. Another approach is to agree in the buy/sell to an annual valuation. This is usually based on the beginning-of-year balance sheet. All partners agree annually to the value and actually sign their agreement. Then, if a triggering event occurs, the value has already been agreed to, removing much potential for conflict.
Though more rare, some buy/sells include a "push/pull provision." This allows for a partner to trigger a buyout directly, by making an offer to buy out another partner, or to have another partner or partners buy the offering partner's interest out at the offer price. This kind of provision lays out a time period for the offer to be accepted or rejected, and once an offer is made, one way or the other a buyout will occur.
Buy/sell agreements are not a substitute for good communication, or for good comprehensive estate planning and succession planning. But they are a powerful tool with great value in helping to deal with uncertainty regarding contingent triggering events and business transitions.
Editor's note: Greg Wolf is a consultant with Kennedy and Coe, LLC (www.kcoe.com) and works to help clients of the firm navigate toward better returns in all areas of their businesses. He is based in the firm's Pratt, Kan., office and can be reached at 620-672-7476.