The cost of a buy-sell agreement depends less on the drafting than on how much of the owners’ negotiating happens at legal rates. A buy-sell agreement is a document drafted from decisions. If the owners have not made those decisions, a lawyer will either draft a form or spend billable time helping them make the decisions. Owners who do the planning first and bring the lawyer a written succession plan pay for drafting. Owners who do not, pay for everything.
This matters most in a business with several owners (partners, shareholders, or members), where the decisions take the longest to reach and where each owner should have legal advice of his or her own.
What are you paying for when a lawyer drafts a buy-sell agreement?
Go to a good lawyer without a plan and ask for a buy-sell agreement, and the lawyer will ask who will be the client and tell you that a written succession plan is needed first, or that there will have to be extensive conferences to gather the information to draft one. Go to a lawyer who does neither, and you will receive a form buy-sell agreement to review. If you execute that document, it will likely do you more harm than good.
The extensive conferences are the expensive part. They are the owners working through transfer restrictions, governance, triggers, funding, and value, one difficult conversation at a time. That work has to be done by someone. The question is who does it, and at what rate.
Whose lawyer drafts the agreement?
Every lawyer must identify a client. A lawyer who drafts a buy-sell agreement represents either the business or one of the owners. A lawyer for the business represents the business, not its owners. A lawyer who has done estate planning for the majority owner and is then asked to draft for the business leaves every other owner with an open question: whose interests is this lawyer protecting?
The rules of professional conduct allow one lawyer to represent clients whose interests conflict only in limited circumstances, and only with each client’s informed consent in writing. On a buy-sell agreement there is no good basis for one lawyer to advise both majority and minority owners. The terms that protect one owner are often the terms that cost another.
The better arrangement is for each owner to develop his or her own sources of legal advice during the planning: an estate planning lawyer, a business lawyer, and a tax lawyer. One lawyer may fill more than one of those roles, and some advisors may overlap among the owners. Each owner manages that for himself or herself. While the owners make decisions together in the planning sessions, each owner’s own lawyers advise that owner on what those decisions mean for his or her estate, taxes, and business interest.
When the plan is written, the owners select the lawyer who will draft the agreement for the business, each advised by his or her own counsel. That lawyer drafts from a plan the owners have already agreed on, and each owner’s counsel reviews the draft for that owner. The negotiating happens among the owners in the planning sessions, not among their lawyers. When owners negotiate through their lawyers instead, every hour of negotiation is billed several times over.
Why does a form agreement cost more later?
A buy-sell agreement works only if the owners follow it when a trigger occurs. The predominant maxim: if a provision of the agreement is not perceived by a party to be fair, that party will not comply with it. A form agreement contains terms the owners never discussed, and the first time they read those terms closely is often after a death, a disability, or a divorce. The worst result is civil litigation. At the least, it will take too long and be very expensive.
What should the owners decide before they call a lawyer?
The issues requiring negotiation, in the order they should be discussed:
- Restrictions on transfer. No owner can avoid the agreement by transferring an interest to someone not bound by it.
- The business entity. The entity is the platform for every control decision, and control issues fuel conflict among owners.
- Governance. How the CEO is chosen and reviewed, and who makes policy.
- Triggers. The events that put the agreement into effect: death, disability, retirement, termination of employment, competition, divorce, deadlock.
- Procedure after a trigger. An exact procedure the owners must follow.
- Funding. Where the money to pay the purchase price comes from.
- Value. The price for each kind of transaction, in strict and clear terms.
Discuss the issues one at a time, at regularly scheduled sessions, and document each session in writing. The accumulated writings become the succession plan. The lawyer drafts the agreement from the plan.
The process: discuss an issue, document the discussion, draft the plan from the documentation, draft the agreement from the plan with the attorney, execute it, and then keep the discussions going so the plan and the agreement can be revised.
What if the owners cannot agree?
Disagreement is the reason for the process, not a reason to skip it. The skill of having difficult conversations among business principals is the essential skill for effective decision-making and successful planning. A few rules make those conversations productive:
- Participants respect one another by listening and allowing each person to speak.
- When a session becomes difficult, end it with an agreement to continue. Letting emotions take over, or breaking off without agreeing to meet again, injures the whole effort.
- Ask questions rather than make statements.
- Distribute the written record of each session to everyone who took part.
- Do not force conclusions. Having the discussion is more important than announcing a solution.
Having these discussions does not change control. It does change what the controlling owner learns. Without them, the people in control are told what others think they want to hear, and a plan built on that information will fail.
A useful exercise is the fire drill. State an event: John dies tonight. List everything John does for the business that he now cannot do. Work through who would do each thing and what would go wrong (Joe would take over for John, but Joe cannot sign checks). Document what you find. The problems the fire drill exposes are the agenda for the next session.
What does the valuation cost?
Value is the issue most likely to break an agreement, and the owners will have difficulty settling it without a certified appraiser. The approach I recommend: have discussions about value first, then bring one appraiser into the discussion. The appraiser develops initial appraisal information, and the owners use it to state a price for each trigger transaction in the agreement.
Repeat the process each year for at least three years, and every other year after that. That may seem expensive, but later appraisals usually cost quite a bit less than the first one. The business’s own accountant is a valuable resource and should be involved, but an appraiser not affiliated with the accountant will be more objective.
A formula is tempting because it is easier to negotiate, but a formula that produces an excellent result today can produce nonsense in the future. Book value is rarely an appropriate transaction price. A stated price, reviewed regularly, is the better practice.
How long should the planning take?
No longer than six months. Take your time and do not force conclusions, but do not fall into paralysis by analysis. Get the plan drafted and start executing it. It will not be perfect. It will be reviewed and revised through a continuing decision-making process.
Who should do the planning?
The planning is process work: scheduling the sessions, conducting the difficult conversations, documenting them, and turning the documentation into a written succession plan. That work does not need to be billed at a lawyer’s hourly rate.
As a consultant, I am hired and paid by the business, and the business is my client. I do not represent any owner, majority or minority, and I do not keep secrets for any of them. Anything an owner tells me is shared with every owner in the planning. That is what allows one person to work with all of the owners at once, which a lawyer for one owner cannot do.
Throughout the planning, each owner has his or her own lawyers for advice. When the plan is written, the professional services follow: the appraiser sets the prices, and the owners, advised by their own counsel, select a lawyer to draft the agreement from the plan. The lawyers’ time goes to advice and drafting, not to the conversations.
The Owner Agreement Project is this process: the owners’ conversations, the written succession plan, and the buy-sell agreement drafted from it. To talk through your situation, contact Business Transition Consulting.
Rick Riebesell is a lawyer and business consultant who has spent over thirty years advising owners of closely-held businesses on succession, buy-sell agreements, and business transactions. He is the Principal Consultant of Business Transition Consulting LLC and the author of Implementing the Buy-Sell Agreement, Now What?, and Business Succession Planning – Forms and Practice Manual (Data Trace Publishing).