Category Archives: Business Planning

Getting Down to Business – Houston with Capital One

Capital One has a great program for small businesses that I wanted to highlight.  If you are interested, then don’t procrastinate as the deadline to apply is coming up on April 1st and there are only 15 slots available.

Capital One’s Getting Down to Business program debuted in Houston in 2009.  The program is a 7-month course for business owners that provides access to information and mentors to help business owners learn about running a business.  The course covers a number of topics including budgeting, credit, planning, structuring, financing, and marketing.  The participants also receive one on one counseling throughout the program.

This program is only for small companies though – those with less than $1 million in annual revenues.  If you are interested, you can apply here.

Key Issues That Should Be Addressed in a Buy-Sell Agreement for Texas Businesses

Buy-Sell Agreements should be found in every private company with multiple owners.  They are invaluable in any number of situations as a tool to avoid deadlock, discord, receivership, or winding up and termination of a company.  Buy-sell agreements may be separate stand alone documents, they may be part of the entity’s governing documents, or they may be part of other agreements between the entity’s owners.

Buy-sell agreements require a certain degree of foresight and prediction about where the company will be a number of years in the future.  These expectations change over time so the owners should periodically review their buy-sell agreement to confirm that it still meets their needs and expectations.

So what are the key issues that a buy-sell agreement needs to address?

Triggers in Buy-Sell Agreements.

Triggers go to the heart of the buy-sell agreement as they dictate the type of events that will cause the terms of the buy-sell agreement to come into effect.  Common triggers are retirement, deadlock, and death.  Other triggers include the voluntary or involuntary transfer of an ownership interest, resignation, or the termination of employment of an owner-employee.

When it comes to determining what triggers a party chooses to include in a buy-sell I find that it is often best for the party to consider what situations he or she wants protection from.  Some common situations to consider include:

  • Protection from the risk of a divorcing owner’s spouse gaining an interest in the business (Texas is after all a community property state).
  • Protection from the risk of other owner’s combining their interests to the detriment of an individual owner.  The “bully” scenario.
  • Protection from another owner with greater resources buying additional control.  Should owner’s have equal opportunity to increase their share of ownership interests?
  • Protection from the risk of bankruptcy of an owner.  Bankruptcy courts wield a lot of power with regard to disposing of debtor’s property.
  • Protection from disagreement among the owners on whether to accept a purchase offer from a third party.  Should the majority be able to force a sale?
  • Protection from termination of an employee-owner’s employment.  How would the former employee feel if his or her salary is terminated and distributions are not made?
  • Protection from a failure to make distributions.
  • Protection from (or requirement for) the application of a minority or lack of marketability discount to any redemption or cross-purchase.  The application of minority or lack of marketability discounts is a hotly contested issue when not specifically addressed with prior planning.

Valuation Methods for Buy-Sell Agreements.

There are a number of valuation methods for a buy-sell agreement.  In some agreements the valuation is set with objective and specific standards such as multiples of earnings, capitalization rate, or book value.  Other agreements might favor a subjective standard or establishing a methodology over objective numbers. Subjective standards typically require the use of third party professionals to establish the valuation.  In this scenario, the buy-sell agreement should outline the factors that a valuation professional may or may not consider in the valuation as well as the process for selecting that professional.

Which method is best depends upon the nature of the business and often times may vary within the buy-sell agreement based upon the trigger event.  For example, a valuation for purposes of redeeming the interest of a deceased owner could be very different from the valuation method used when one owner is opting out or threatening the sale of his interest to a third party.  In the former scenario it might be more appropriate to allow for a valuation that considers future profits and opportunities, while the latter scenario might warrant application of a discount for lack of marketability or minority status.

Funding of Buy-Sell Agreements.

The best drafted buy-sell agreement can be rendered worthless because of inadequate planning for how the parties will fund the required purchase under that agreement.  One of the most common funding mechanisms is insurance but this funding method is typically only available in limited circumstances such as death of an owner.  So what are the other options?  Borrowing, installment sales, and personal resources are the most common alternatives though each has certain benefits and risks associated with them.

Borrowing the funds to implement a purchase pursuant to a buy-sell agreement necessarily assumes that the borrower (whether another owner or the entity) will be able to secure a loan.  Prudent planning may necessitate clauses in a buy-sell agreement that require sufficient reserves, whether in cash or assets, to increase the likelihood that the purchaser will be able to secure funding necessary to effect the purchase.

Installment sales are another alternative that usually come with the benefit of avoiding the need to qualify for a loan.  This is a significant benefit that can allow for less hassle and an efficient implementation process when the buy-sell agreement is triggered.  However, this structure can carry significant risk for the seller as the payment structure relies heavily on future income.  What happens if revenues decline?  Will the seller be compensated for the additional risk with a higher interest rate on the payments?  If so, what is the appropriate rate?  Will the buyout payments receive priority?  Is the seller going to take a security interest in business property or possibly the personal property of the other owners?

Additional Matters to Address with a Buy-Sell Agreement.

A significant consideration is determining how the purchase and sale will be structured.  There are usually two options: a cross-purchase or a redemption.  In the cross-purchase scenario, the interest is purchased by all or some of the other owners of the entity.  Under the redemption scenario, the interest is purchased by the entity itself.  Each has its own benefits, impacts, and risks to the other owners and prudence dictates carefully considering each scenario to determine how the purchase and sale should be structured.  This is another area where the structure of the transaction may differ based upon the triggering event.

A buy-sell agreement carries with it certain additional requirements to be effective.  For example, a buy-sell agreement that imposes restrictions on the transferability of corporate stock carries with it certain notice and record keeping requirements that must be met for those restrictions to be enforceable.

In addition, effective implementation of a buy-sell agreement may require amending the entity’s governing documents, shareholder or partnership agreements, or other documents related to the entity.

How Business Planning Can Benefit You and Your Company

I’ve often found that the concept of “business planning” is a little esoteric for clients who aren’t quite sure what it means, how it works, or what sort of benefits they receive through planning.  So let me answer those questions here.

Who Needs Business Planning Services?

Everyone.  That is the easy answer but the practical answer is a bit different.

New companies often have a tight budget that requires picking and choosing which services the company engages early on.  Legal services are often not high on the list of priorities, as unwise as that may be.  Instead, a lot of folks take the do it yourself approach or use one of the online document services in an effort to cut costs.  Needless to say, I disagree with this approach and wrote about the dangers of online document services here.  But I understand the cash crunch when companies start out and I won’t argue with those decisions here.

However, at some point there is a cost benefit analysis that business owners have to engage in.  At what point does the time he or she spends playing lawyer start to take away from the bottom line?  At some point in time it becomes more beneficial to spend his or her time selling their product or providing their services.  Perhaps more importantly, at some point the business becomes successful enough that the business owner needs to start addressing the corners he or she cut starting the business and protect the benefits of all that hard work.  Failure to do so could put all of his or her hard work at risk.

How Does The Business Planning Process Work?

The actual end product is different for everyone but the process in getting there usually goes something like this.  The first step in the planning process is to identify your ultimate goals and objectives.  Asset protection and risk minimization are usually high on that list but often times there are other goals in play such as preparing the company for sale or for transfer across generations of family members.

After identifying your goals and objectives, you will sit down with counsel and analyze the company from top to bottom, from day to day activities to long-term liabilities and commitments.  The goal is to identify specific areas of risk that need to be addressed.  The process should look at both internal risks and external risks.  You also need to identify key tangible and intangible assets that could be protected through various methods and structures.  Depending on the additional objectives set out, there may be other issues or areas requiring further review.

Based on the goals identified initially and a review of where the business is today, counsel then develops one or several options for how to put the business in a position to best achieve the goals and objectives identified by the client.  Often times there are multiple options for the business owner to choose from that require a balancing of the goals and objectives set out at the beginning of the process.  One plan may offer a higher level of asset protection, but come at the expense of greater difficulty in transferring those assets in the future.

What Are the Benefits of Business Planning?

Confidence. Security. Comfort.  The knowledge that your company has been placed in a position to both protect the effort and hard work you put in over the years as well as achieve your objectives in the future.

Owning and running a business comes with a number of burdens and concerns that never fully go away.  With proper planning, you can put your company and yourself in a position of comfort by knowing that you are well situated to deal with the inherent risks and protect a lifetime of hard work.  You can move on to focus on running your business with confidence that your assets and income are secure.

Why Online Business Documents Could Be The Choice That Destroys Your Company

There are a number of do-it-yourself online legal document services that have popped up over the past few years.  The appeal is obvious – they are cheap.  Most folks who start or run a business know they need governing documents, contracts, and a number of other legal documents.  Lawyers are expensive and these document services… Continue Reading

IRS Adopts Final Regulation Requiring Updates to Employer Identification Number Information

The IRS recently adopted a final regulation requiring companies (and individuals) to update the information provided in the application for their employer identification number. You can read the final rule here. The final regulation states the following basis for the rule: Some EIN applicants continue to list individuals temporarily authorized to act on behalf of… Continue Reading

Closely Held Corporations: Characteristics, Minority Shareholder Rights, and Control Issues

Closely held corporations present unique legal issues on a number of fronts.  The limited ownership group makes personal relationships more important and increases volatility amongst the group.  Owners of closely held companies tend to be more involved in the operations of the company. What Is a Closely Held Corporation? The most general definition of a… Continue Reading

New SBA Tool for Small Business Owners

The SBA yesterday announced the launch of a new tool to assist small business owners: Small business owners and start-ups across the country can now take advantage of a new business tool to help them compete and grow.  The free tool, called SizeUp, helps businesses identify new customers and compare their performance against other businesses… Continue Reading