Are You Ready for Your Business Succession and Exit?

We are often asked to help a business through a transition involving a sale, acquisition or a succession within a family, with co-owners or with key employees. Given that these transitions may evolve over a long period of time, it is important for owners to plan “exit strategies” to maximize their business value and achieve their exit goals. Although the terms of each deal are unique, the following issues often come up and require negotiation among the parties:

1. Buy/Sell Agreement (aka Business Continuity Agreement): These provisions are important for business continuation because they specify the conditions for transferring the partners’ interests in a business, with the goal of identifying who can (and who can not) acquire the interests; the triggering events for the transfer (e.g., resignation, death, disability, bankruptcy, divorce, business disputes, etc.); and, the method to value the interests at the time of transfer.

In essence, the remaining owner(s) agree to purchase the interest of the departing owner pursuant to the terms of the agreement. Without such an agreement, a business could falter if there were problems with the withdrawing owner, an ex-spouse or heirs. An important component of a buy/sell agreement is the funding mechanism to buy out the interest and pay any estate taxes, to accomplish the transfer, such as “key person” life and disability insurance.

2. Earn Out Provision: The acquirer may want to pay part of the acquisition price over time, through an earn-out provision. Thus, some amount is paid when the deal closes and the balance is contingent on the company’s future performance. Certain target goals are set for several years in the future for such metrics as gross revenue, earnings, net income, new customers, etc. Of course, care must be taken to ensure that the targets are not made difficult to achieve or manipulated (e.g., reducing the marketing budget, increasing or inflating overhead expenses, making unexpected capital expenditures, poorly operating the business, customers preferring to deal with the prior owner, change to the company’s operations, etc.)

The seller can monitor the company’s future business if it negotiates a new role as an employee or consultant, with limitations on the buyer’s ability to replace the seller. Monitoring may also be achieved by retaining rights to audit the company’s books. A dispute resolution provision can be helpful so the parties know in advance how disputes will be settled.

3. Non-compete provision: A covenant not to compete may prevent the seller from competing with or diverting business away from the company. A non-compete provision may not trouble a retiring owner but it may concern a younger seller who is prepared for the next business venture. Non-compete agreements are enforceable in Massachusetts, especially those contained in an agreement to purchase a business. (However, new legislation has been discussed in Massachusetts in recent years to regulate non-compete agreements in the employment context.)

Although non-compete agreements are judged on a case-by-case basis, enforceability often turns on whether the agreement is supported by “consideration” at the time it was signed (such consideration is typically found in the purchase of a business); is tailored to protect a legitimate business interest, such as prohibiting the individual from soliciting the company’s customers, protecting trade secrets, and protecting good will; and, is reasonably limited in terms of its duration, geography, and scope.

Business succession raises additional issues concerning future management, business valuation, tax liabilities, legal structures, and the like. A proactive owner should consider these issues with trusted advisors (e.g., accountant, financial planner, insurance agent, attorney, etc.) in order to plan a rewarding exit.

Please contact me if you or a colleague has a question on business succession issues or this post..