A Buy/Sell Agreement, also called a business pre-nuptial agreement, or a business will, is a legal document that is used as the mechanism governs business owners when one of them leaves the business. The reality is that every business owner is going to leave. The reasons could be the owner quits, dies, becomes disabled, retires, or is fired. Buy/sell agreements can also alleviate problems creating with shareholders going through a divorce. Here are five mistakes often overlooked in Buy/Sell Agreements.
- Valuations are not updated-The most common changes that happen in a privately owned business are that the value of the business changes over time. If the business valuation is not updated then if a triggering event occurs what happens?
- The Buy/Sell Agreement calls for multiple Appraisers-This can be a very costly proposition. The agreement will state that an appraiser for each side values the business and if they are not within a certain percentage, then a third appraiser is hired. This can be very costly paying for up to three appraisers. A better approach is to have one appraiser who updates the appraisal on a consistent basis (every two years or so).
- Using a Formula Method to Value-using a formula method can certainly cut costs on a formal appraisal and may seem easy, but in most situations the value of your business interest is your biggest asset. Wouldn’t you want to know with a high level of certainty that you are getting and/or paying the accurate amount for the business?
- Not properly funding life insurance proceeds-In the worst case scenario the shareholder passes away and his heirs are paid with life insurance proceeds. The Internal Revenue Service assesses a value much higher than what is reported on the estate tax return. The heirs now have a tax bill and in addition, don’t receive full value for the business.
- The wrong standard of value is used-the standard of value is predicated on state law. This is where the appraiser and the attorney work together to make sure that discounts are not taken where they are not appropriate.
Buy/Sell Agreements are meant to provide the means to transfer ownership interests in a business during the triggering event. The correct valuation is a critical component of those means. Hiring a qualified thought leader in the industry will help alleviate the stress that comes this important succession planning tool.
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