Establishing the “WHY” in Business Buy Sell Arrangements for SME Business Owners



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THE MISCONCEPTION

When people hear of buy sell arrangement, the first impression they have is a legal arrangement to protect their own interest in the business against their business partners.

This perception is absolutely not true! In fact, business buy sell arrange- ment cannot be done if any of the business partners is NOT in talking terms with the rest. It can only be prepared when everybody is in good working relationship. It is not about “protecting my business interest against my partners or “eating their shareholdings”, but it is to preserve the value of the entire business for every single partners & their families against external parties when any of the partners are hit by unfortunate incidents.

Most business owners (where the active directors are not family related) whom I’ve met fail to see the consequences of not having a proper buy sell agreement until I put them in the shoes of the sole surviving directors of the business. For simplicity’s sake, let’s assume there are only 2 directors; one holds 70% shareholding while the other holds the remaining 30%. The trigger event is death, although other events like total permanent disability or critical illnesses can also trigger a buy sell arrangement.

 

VISUALISE YOU AS THE MAJOR SHAREHOLDER CUM DIRECTOR

The major shareholder, most of the time, is not as actively as involved as the minor shareholder. This is not to say he is entirely passive, but most of the “outbound job scope” or “external operations” are handled by the minor shareholder, who is likely to be younger. But the partnership works because the minor shareholder adds value to the business by his active involvement while the major share- holder (likely older) provides the capital required to get the business rolling. But when your minority “active” shareholder dies, you need to find another business partner (likely younger) to replace him. Of course, without a buy-sell agreement, you keep your deceased partner’s widow’s interest in the business because you do want to take care of his family as well. But the question is how you are going to rope in a new partner? By willingly diluting your own shareholding or by diluting your deceased partner’s shareholding? And if you were to put yourselves in the shoes of a prospective partner, how attractive I would it be to join a business but only have, say, 15% shareholding, and do most of the work while the widow is getting another 15% of the business interest without doing anything?

It is hard. The ideal arrangement would be that your deceased partner’s widow cashes out from the business at a fair value as agreed upon. Then you could take in another partner with 30% shareholding as a replacement.

 VISUALISE YOU AS THE MINOR SHAREHOLDER CUM DIRECTOR

Now, let’s see what happens when we reverse the scenario. Say, if you are the minority shareholder, and your majority shareholder never comes back from his vacation.

Without a buy sell agreement and the corresponding proper funding, you will now negotiate with his heir on the value of his 70% share of the business you’ve both built over the years. When it comes to business valuation, it is usually a very subjec- tive matter, which may lead to dispute. Apart from that, additional cost and delay are involved if you go for the valuation process. But this is just the tip of the iceberg. Because even if the negotiation goes well, you now need to cough up the funds to buy out your deceased’s partner 70% shareholding. Getting this no small amount is a burden for most business owners, especially if you are hitting the gearing limit. The other option is using your own assets as collateral, if you still have assets which are not encumbered. This is certainly not the best option as every smart business owner knows very well you only borrow for profit generating activities. This surely isn’t.

The reality of business is when things as such happen, banks may take away the umbrella they provided to you during the good times. Realisti- cally, can businesses still run when suppliers lose confidence of your business? For instance, suppliers will now be requesting upfront cash payment instead of Net 60 terms. Also, do you think you will face a situation where your debtor will take the opportunity to delay payment and on the other hand your creditors come after you for unsettled bills?

Even if you can borrow money from banks, at what rate is your interest per annum? Compared to the most common funding in business-sell agreements, smart business owners know the cost efficiency of using the bank’s money versus paying insur- ance premiums.

And don’t forget the fact that the heir of the majority shareholder still has the say in the business. For you it is close to impossible to rope in another shareholder in in this scenario. The worst we’ve seen is when the majority shareholder appoints a proxy to run the business together with the surviving minority share- holder and dictates what he can or cannot do. How would you feel if you were the minority shareholder in this case? Would you quit?

What sense does this make if you can prevent this from happening from the very start?

 {It is a lose-lose situation because the company essentially becomes an empty shell when the minority shareholder leaves the company with its customers and sets up a new one.}

“I AM VERY BUSY”

“Being busy” is an overused word. No one is too busy, it’s all about priorities. If you have shed blood and tears for years in building your business, what makes you too “busy” to ensure its value doesn’t get driven down by unforeseen circumstances?

Imagine if you are having a hearty dinner entertaining your big client for a huge business deal. If you suddenly feel an increasingly sharp pain in your left chest, can you ask your heart to wait because you are “busy”? All other matters are of second priority at that moment except getting to the hospital and fighting for your life.

If you have been reading this far, I only have this to say:

Your business is profitable because of you. Your family is comfortable because of you. Your bankers and suppliers trust you because of you. Salaries and wages are paid on time because of you. Your creditors trust you because of you.

Trust is a business’s true value.

So isn’t it wise to remove you from the equation but still retain the trust factor for all the people involved, for just a fraction of the cost and time?

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