5656 E. Grant Road • Suite 200
Tucson, Arizona 85712
(520) 886-3181
Fax: (520) 885-3699
www.hblcpa.com
NEWSLETTER
Buy/sell agreements: Don’t be without one
A
buy-sell agreement is one of the most important
legal documents a closely held or family
business can hold, along with the legally
necessary documents such as articles of incorporation
and partnership agreements.
Business owners involved in closely held corporations and noncorporate types of entities – such as
proprietorships, partnerships or limited liability
companies – should have
Without a buy-sell
a well-drafted buy-sell
agreement, businesses
agreement in the event of
face peril when owners
death or disability of the
die, become incapacitated, owner or the owner’s
wish to sell or transfer
divorce, file bankruptcy,
interest in the company.
A buy-sell agreement
retire or decide to sell.
addresses how and when
owners can sell and must
sell their shares. A well-drafted buy-sell agreement also
formulates valuation criteria. Without a buy-sell agreement, businesses face peril when owners die, become
incapacitated, divorce, file bankruptcy, retire or decide
to sell.
The consequences of not having a properly drafted
buy-sell agreement in these situations can, and usually
do, lead to expensive litigation and possible business
failure.
The best time to make a buy-sell agreement for any
business is before the first penny of income is
generated. But a business can generate and agree to a
buy-sell agreement once the business is in operation.
A buy-sell agreement provides for smooth transition of a business interest, according to the Center for
Financial, Legal & Tax Planning Inc., by:
▲ Identifying triggering events
▲ Specifying to whom or to what the business
interest must be sold
© 2015 CPAmerica International
▲ Providing a mechanism to determine the purchase price
▲ Providing a funding source
▲ Establishing a valuation for estate tax purposes
The basic forms of buy-sell agreements are stock
redemption agreements, cross-purchase agreements
and the mixed agreement.
A stock redemption agreement, also known as stock
restriction agreement, provides for the purchase of an
interest by the entity itself, as differentiated from an
agreement between business associates.
A partnership redemption plan, referred to as an
entity plan, provides for the partnership to retire the
exiting partner’s interest under
specific conditions. A corporate stock redemption plan,
used
in
closely
held
corporations, provides for the
corporation to redeem or retire
the affected shares.
A stock redemption agreement requires corporate
approval because the agreement involves the corporate
entity repurchasing the affected
stock. The stockholders approve
and sign the agreement with
the company. Usually the company has only one agreement
approved by the company and
signed by all stockholders.
The cross-purchase agreement takes the form of a contract among stockholders.
The stockholders purchase an existing shareholder’s
share of the business interest on an individual basis.
A cross-purchase agreement among partners/
shareholders provides that if one partner exits, the
See Buy/sell sgreements inside
March/April 2015
S E E
✓Does your board
need an outside
member?
✓How cash flow
impacts the sale
of a business
✓How to deal
with online
complaints
I N S I D E
Does your board need an outside member?
B
oards of directors in closely held businesses are
typically comprised of the owners or officers of the
company. They handle higher level or strategic
business decisions in the operation of the company.
Unlike public companies, private companies are not
required to include outsiders on their boards. That doesn’t
mean, however, that outsiders should not be a part of the
board.
There are many good reasons to include an outsider or
two on your board. Consider the following:
1. Objectivity – An outside director, by definition, is
not an employee or officer in the company so may be more
objective when considering alternatives affecting the
business. With less “skin in the game,” outsiders may offer
additional food for thought to the conversation. Their
opinions will likely be less influenced by conflicts of
interest that may affect insider directors.
2. Broader experience – Outsiders can bring much
needed experience and expertise to a closely held company
board. Perhaps the owners and officers are knowledgeable
in the industry but not well versed in technology, finance or
human resources. Outside directors who are skilled in these
areas can bring much needed information and perspective
to decision-making discussions.
At a minimum, the outside director’s vote may save the
company time and money.
If you are thinking of adding an outsider to your board,
here are some important issues to consider:
How to select outside board members
In selecting an outside board member, remember the
benefits noted above and
let them help guide your
selection process.
Unlike public companies,
The outsider should
provide value in the form private companies are
of experience, expertise not required to include
or knowledge that will
outsiders on their boards.
supplement the board.
It is also essential that That doesn’t mean,
outside board members however, that outsiders
are objective. Choosing
close friends of current should not be a part of
board members, family the board.
members, vendors or
customers could be
problematic. While they may bring expertise, their
objectivity may be difficult to maintain.
How to compensate them
Out side directors are usually compensated for their
services in some way. They are generally expected to
prepare for and attend board meetings, so their time and
expenses should be covered.
An hourly rate or a standard fee per board meeting
could be used as the basis. The actual amount should be
agreed upon when the outside member joins the board.
How official the outsider's status is
The legal status of the outside board member must also
be decided and appropriately documented.
Some outside directors serve in a purely advisory capacity. Their input is offered and considered, but the inside
members of the board can make its decisions without
regard for the outsider’s advice.
In other cases, however, the outside board member is a
legal member of the board whose input and vote must be
considered. If this is the case, you will need to be sure your
articles of incorporation and bylaws adequately reflect
this. Consult your company attorney for assistance.
How to document outside board member in
corporate records
3. Ability to break a tie – If the ownership of your
company is divided such that a tie is possible in a voting
situation, an outside director can act as the tie breaker. This
can be critical because a deadlocked board can inhibit the
company’s progress – which could possibly result in legal
battles. If owners have agreed to allow the outside director
to break a tie in a way that is legally binding, the result may
be more willingness to continue discussion until a resolution can be reached without involving the outside director.
March/April 2015
Board members also have a degree of liability with
regard to the decisions they make on behalf of the company.
Insiders and outsiders alike will benefit from liability
coverage known as directors and officers insurance.
How to maintain confidentiality
Finally, confidentiality is very important in closely held
businesses. The outside directors should sign a confidentiality agreement prior to joining the board, whether in an
advisory or a legally binding capacity. – Denise Altman,
CPA, M.B.A.
How cash flow impacts the sale of a business
A
ppraising a business can be approached from a number
of different directions, including book value of assets,
capitalized income and discounted future earnings.
One practical step to take, especially when selling a small
business, is to look at cash flow in relationship to debt coverage.
Unless the purchase is in cash, the buyer will most likely seek a
bank loan. The seller might also provide some of the financing,
especially when the intangible value is significant.
Bank loans are based on the values of land, buildings,
equipment, inventory and other tangible items. Land and
buildings can be
mortgaged with
a loan of up to 20
years, but everything else will
require a shorter
term because of
quickly diminishing value.
The
bank
might do two
loans – one for
the building and
another for all
other business
assets. Accounts
receivable are
considered an
asset if they are
transferred to
the new ownership. These are
not
loaned
against dollar for
dollar, so only a
portion can be
financed. The
age and quality
of the receivables
also affect their
value.
Buy/sell agreements continued from front
remaining partners/shareholders will receive the exiting
partner’s interest in exchange for the price specified in the
agreement.
Proprietors may make similar agreements with key
employees, while partners or shareholders in closely held
corporations may make such arrangements with other partners or shareholders or key employees. Each shareholder or
partner usually signs a separate agreement with every other
stockholder or partner. The agreements do not have to be the
same. Each is unique to the parties signing the agreement and
is only between the parties signing that agreement.
Mixed agreements are the third type of buy/sell agreement.
The entity is given the first option to purchase the shares of a
stockholder. To the extent the shares are not purchased by the
entity, they can then be purchased by other shareholders
usually in direct proportion to the ownership. If the shareholders do not purchase all of the remaining shares, the
As part of the loan process, the bank officer will evaluate
the last three years of tax returns from the business.
Discretionary items, current interest payments and noncash
expenses such as depreciation and amortization are added
back to net income.
This adjustment is applied to all three years, and an average
is determined. The officer then sees whether this cash flow
from operations is sufficient to cover the proposed debt
payment.
This debt will include loans from the seller. To make a loan
viable, the debt coverage ratio must meet a certain threshold,
usually 1.25. To calculate the ratio, divide annual cash flow by
the total annual sum of current debt. If the ratio is below the
threshold, the loan will likely be denied.
In some cases, if the buyer can present a compelling case as
to why their management will significantly improve operations, the bank might approve it.
The question of loan approval aside, buyers need to create a
cash flow for their own purposes. Although they are purchasing
an ongoing enterprise, they have the latitude to operate the
business any way they choose.
This could mean additional investment or increased
efficiency. When a business is in a mature or declining stage, it
often has areas that can be improved. For example, perhaps the
former owner has been absent while the new owner will be on
site, thereby reducing some payroll costs.
As part of the due diligence process, each expense item
needs to be examined to see if it can be improved. New quotes
for insurance, inventory, advertising, professional services
and other expense items can be obtained.
Sometimes rent can be negotiated for a break during the
first few months of transition. Pricing can be checked to see if
it is accurate, with a first indicator the ratio between sales and
cost of goods sold. Sometimes businesses experience leakage
of revenues that aren’t booked.
The final cash projection will help the buyer determine
whether this business is a good investment. Not only should it
generate enough cash to pay expenses and loan payments, it
needs to compensate the new owner. A healthy profit will also
ensure there is money for reinvestment and growth. – Elizabeth
Penney, M.B.A.
entity may purchase the remaining stock.
In many agreements, there is a clause requiring either the
entity or the remaining stockholders to purchase “all or
nothing.” Therefore, stockholders and companies are Good things happen
banned from purchasing just when you plan to have a
enough stock to give them
controlling interest in the buyout agreement that spells
company, according to The out the owner's rights
Center for Financial, Legal &
and obligations when an
Tax Planning, Inc.
Good things happen ownership transition occurs.
when you plan to have a
buyout agreement that spells
out the owner’s rights and obligations when an ownership
transition occurs. – Tracy A. Heider Winrow, Attorney, CPA
March/April 2015
5656 E. Grant Road • Suite 200
Tucson, Arizona 85712
(520) 886-3181
Fax: (520) 885-3699
Customer power: How to deal with online complaints
T
here’s no getting away from the fact that no matter
how strong your product is, at some point, you’re
going to have dissatisfied customers – hopefully not
too many, but likely a few.
While resolving problems quickly has always been critical, the speed at which customers can spread the word
about their bad experience today makes it super-critical.
Customer review sites are abundant: Yelp, CitySearch,
Merchant Circle, Superpages, Urban Spoon and Trip
Advisor are some of the most common.
Whether you sell your products and services to
individuals or businesses, you have to pay attention to
online feedback. Tools are available to help you monitor the
online buzz about your company, products and services.
Some are free, others require a subscription.
Social media monitoring sites or a tweet deck can help
you find online mentions. It’s important to find a service
that looks in the places your customers are most likely to
engage.
A recent study by Accenture found that 9 out of 10
customers are frustrated by having to contact a company
multiple times for the same reason, by being put on hold for
a long time and by having to repeat their issue to multiple
representatives.
Think about your business. What do customers have to
go through to buy from you? Do customers have to jump
through hoops that make your life easier, but don’t add to
the quality of their experience?
On the positive side, a study by LivePerson found that
82 percent of consumers say the No. 1 factor that leads to a
great customer service experience is
having their issues resolved quickly.
Customers don’t expect you to be
perfect, but they do expect you to
respond and resolve their issues.
So, what happens when you see the
negative comment in cyber-space?
How should you react? Consider it an
opportunity to correct a problem.
Look at the comment in context. Is it a
common complaint? Is it one negative
comment among dozens of positive ones?
Never argue with a customer online. You might invite
the customer to contact you directly so that you can discuss
the issue more fully instead.
If the issue has appeared frequently in online comments,
take a hard look at what is causing the dissatisfaction, and
let the audience know you’re addressing it. Be careful not to
sound condescending or impatient. These are your paying
customers, after all. – Denise Altman, CPA, M.B.A.
This newsletter is published by HBL CPAs, P.C., a Professional Corporation of Certified Public Accountants.
The technical information in this newsletter is necessarily brief. No final conclusion on these topics should be
drawn without further review and consultation.