As the saying goes…. “Don’t get into business with ANYONE without first defining how you’ll get out of ownership.”
Starting a business or deciding to share ownership can seem straightforward initially. However, a critical aspect often overlooked is defining how each owner will eventually exit that ownership. After 50 years of working with business owners, we can attest to the fact that 100% of owners will, at some point, transition out of their business ownership. We can also attest to the fact that being prepared can make things go much smoother in what can be a stressful time.
Triggering Events
Owners need or want to exit the business for a variety of reasons, known as triggering events. These include when one of the owners:
- ● has ended their employment with the company (quitting).
● has ended employment due to being fired for cause.
● has been laid off due to business struggles or disagreements.
● has died or become disabled.
● is retiring.
Importance of Clear Valuation Provisions in Legal Agreements
It’s essential to establish an agreement as to a fair process for determining the business’s value under each triggering event. These processes, or provisions, are then embedded into legal agreements sometimes referred to as Buy/Sell Agreements, Shareholder Agreements, or Operating Agreements.
While an attorney drafts the legal terms, the specific valuation provisions must be defined based on the owners’ intentions before knowing which owner is leaving. Down the road, once it is clear who the buyer and seller are, defining fairness becomes challenging due to conflicting motivations driven by self-interest.
Too frequently we see owners at odds with each other because one wants or needs to be bought out, and no agreement exists between owners for how this should play out. Even when an agreement does exist, it only addresses death or disability, which are less likely to occur compared to other events. To ensure all scenarios are clearly defined, it’s crucial to discuss, define, and document how the owners perceive the valuation process for each triggering event.
Our Approach
Our team has developed a matrix that we work through with business owners to capture their intent under each of the triggering events while explaining the impact of their decisions on business value. This is then summarized and shared with the attorney to incorporate into the legal agreement.
Other than retirement, when a business owner leaves the business, it is typically a stressful, emotional, and generally unexpected event. It’s unrealistic to think you can agree on a fair or reasonable valuation method at that time with a soon-to-be ex-owner or their family/estate.
Instead, having clear, predefined valuation provisions for each triggering event ensures a smooth exit process and provides a roadmap for exiting ownership. A relatively low investment of time and money now can save a lot of headaches and heartache later.
Conclusion
By defining and incorporating unambiguous valuation provisions for each triggering event into the owners’ buy/sell or other legal agreement, owners can avoid the nightmare of serious disagreements or even litigation.
If you would like to discuss a specific business situation please schedule a Complimentary Consultation or call us at 608-257-2757.
