Planning ahead for when a partner leaves the business
Recently, I've had several conversations where agency owners are brainstorming creative ways to reward members of their leadership team. Usually, this amounts to someone donning a new title—a manager becomes a director, or a director becomes a VP. Another option involves setting up a profit pool so people can share in the agency's success. A third, increasingly popular conversation is also cropping up: how to navigate the distribution of equity with new partners.
Partnership conversations allow agency owners to envision a future of collaboration—one where they can share the weight of decision-making and agency management. Such conversations usually focus on two points. These are current state (division of roles and responsibilities) and future state (goals and objectives). In reality, partners rarely discuss what happens when someone decides to leave the relationship. A buyout agreement is designed to fix this issue; it ensures that you and your partner(s) are prepared for the what-if situations that arise with business partnerships.
WHAT-IF SCENARIOS
Under a buyout agreement, there are many what-if scenarios that could trigger the buyout of a partner's interest. Below are a few examples:
What if a partner wishes to resign or retire from the agency?
What if a divorce settlement stipulates that a partner's ex-spouse receives equity in the business?
What if a partner wishes to cash out their equity for financial reasons?
What if a partner receives an offer from an outsider to purchase their equity?
What if a partner become disabled, incapacitated, or dies?
The buyout agreement ensures that when (not if) you encounter one of these situations, the other partners have a plan in place to continue running the business. One partner leaving the business should not mean the demise of your agency.
WHY YOU NEED A BUYOUT AGREEMENT
A buyout agreement, also known as a buy-sell agreement, is a contract between business partners that governs what happens when a partner leaves your agency in a what-if situation. The buyout agreement establishes a succession plan to instruct and remind everyone that there is a plan to handle the sale or buyback of an ownership interest. Buyouts are usually structured so that if a partner leaves, they cannot open a competing marketing agency within a stated period of time and/or they cannot approach former clients. The reality is simple: all business partnerships eventually come to an end, whether amicably or not. To be prepared, you must plan for these untimely situations before they happen by drawing up a buyout agreement.
As a best practice, you should aim to set up a buyout agreement when you create your partnership agreement. The buyout agreement can be part of the agreement itself, or a separate legal document. To begin establishing a partnership buyout agreement, the first step is conducting a business valuation. You will need to seek out an independent appraisal to assess the fair market value of your business. Valuing a partner’s interest is normally the most contentious part of a business buyout. You want to ensure that you have an updated (every two to three years) valuation, so no one feels cheated if a buyout agreement gets triggered.
FUNDING A BUYOUT AGREEMENT
A partnership buyout agreement is funded through installment payments. These can be derived from the assets of the business, or from the proceeds of an insurance policy.
Business Assets: A buyout agreement may stipulate that the business can pay with the income earned from the business, over a period of time. For example, a payment plan may allow your agency to put 10 or 20 percent down and pay the remaining balance in installments over five or ten years.
Insurance Policy: Many agencies purchase life insurance policies, and sometimes disability insurance policies, for each partner. If the partner dies or becomes permanently disabled, the agency can use the proceeds of the policy to buy out the departing partner.
Your partnership buyout agreement may exist as its own document, or as part of a partnership or operating agreement. Agency partnerships (or any co-owned business, for that matter) are not legally required to have a buyout agreement. However, going through the work of putting a buyout agreement in place, you must ensure that all agency owners sign the agreement. Remember that the buyout agreement should be updated in various situations. For instance, changes should be made if you believe the valuation may have shifted substantially, or if you bring new partners into the ownership structure. It is helpful to think of a buyout agreement as the business equivalent of a prenuptial agreement between you and your partners. Although you want the partnership to last forever, what-if situations can and will occur. In these cases, the buyout agreement instructs everyone how to handle the sale or buyback of an ownership interest with grace.