How can I ensure the continuity of my small business?
Launching a small business involves a number of critical decisions such as selecting the right business structure and putting in place agreements that clarify the relationship among the owners and/or partners such as partnership and shareholder agreements. If the business is structured as a partnership or a small LLC, it is also crucial to institute a buy sell agreement.
This legal document specifies how the ownership interest will be redistributed in the face of unexpected events such as the death, disability, bankruptcy, or divorce of one of the owners. In short, a buy sell agreement affords the surviving owners with a means of redeeming the stake of the departing owner.
Types of Buy Sell Agreements
There are three types of buy sell agreements: cross-purchase agreements, stock-redemption agreements and hybrids.
- Cross-purchase Agreement - typically utilized by entities with only a few owners, such as partnerships, which allows the remaining owners to directly purchase the departing owner's interest.
- Stock-redemption Agreement - the corporation redeems the departing owners shares which raises the value of the remaining owner's shares.
- Hybrid - combines the features of cross-purchase and stock-redemption agreements by giving the remaining owners an option to redeem the shares if the business is not able to do so.
Determining the Valuation
Buy sell agreements should also clarify how the business will be valued, and there are generally three valuation methods: the asset approach, the income approach and the market approach.
- Asset approach - business value is determined by evaluating the stated assets and subtracting the liabilities, without factoring market conditions or good will.
- Income approach - evaluates past earnings and projecting future earnings, as well as future cash flow and capitalization, as a means to determine the present and/or future value of the business.
- Market approach - analyzes the sale of comparable companies in the same industry that factors differences in size, duration and market risk.
The Takeaway
Without a well designed agreement in place, a number of complications can arise that can adversely affect the business. For example, if one of the partners gets divorced, the ex-spouse could be entitled to a share of the business since Texas is a community property state. Similarly, if one of the owners dies, the surviving spouse and other family members could also have a seat at the table. In the event of a bankruptcy, a business may find it has a bank as a partner. In sum, a well designed buy sell agreement can minimize conflicts and confusion if unplanned events arise. By engaging the services of an experienced business law attorney, you can ensure the continuity of your enterprise.