Riding the Economic Waves: How Economic Conditions Can Capsize Your Buy-Sell Agreement

Riding the Economic Waves: How Economic Conditions Can Capsize Your Buy-Sell Agreement

by | May 19, 2025 | ESOP Business Valuation

For closely-held business owners, a buy-sell agreement is a cornerstone of succession planning and business continuity. It’s the “pre-nup” for business partners, outlining what happens if an owner departs, whether due to death, disability, retirement, or other triggering events. A critical component of these agreements is the mechanism for valuing the departing owner’s interest. But what happens when the economic landscape shifts dramatically between when the agreement is drafted and when it’s triggered?

Many business owners treat their buy-sell agreement as a “set it and forget it” document. This can be a costly mistake, especially when economic tides turn. Fluctuating economic conditions can significantly impact the fairness and feasibility of a buy-sell agreement, potentially leading to disputes, financial strain, or even the unraveling of the business itself.

Proactive Steps to Weather the Economic Storm:

So, how can business owners ensure their buy-sell agreements remain fair and functional regardless of the economic climate?

  1. Regular Reviews are Non-Negotiable: Don’t let your buy-sell agreement gather dust. Review it annually, or at least every 2-3 years, and specifically after any major economic shift or significant change in your business.
  2. Flexible Valuation Mechanisms: Avoid fixed values for extended periods. Consider using a formula that incorporates current financial data and perhaps industry-relevant multiples. Better yet, stipulate a process for valuation at the time of the trigger, such as an agreement to hire one or more qualified, independent business appraisers. This ensures the valuation reflects the conditions at the time of the buyout.
  3. Multiple Funding Options & Contingencies: Regularly review life insurance coverage to ensure it aligns with the business’s current value. Consider a sinking fund or other savings mechanisms. Outline provisions for seller financing, including how interest rates will be determined (e.g., tied to a benchmark prime rate).
  4. Consult Your “A-Team”: Work with experienced legal counsel, a CPA, and potentially a business valuation expert when drafting and reviewing your buy-sell agreement. They can help you anticipate various scenarios and build in appropriate flexibility.

A buy-sell agreement is a living document that must adapt to the evolving realities of your business and the broader economy. By proactively addressing the potential impacts of economic conditions, you can protect your business, ensure fair treatment for all own owners, and maintain the stability you’ve worked so hard to build.

 

Colorado Boosts Employee Ownership with New Tax Incentives

Colorado Boosts Employee Ownership with New Tax Incentives

by | Apr 10, 2025 | ESOP Business Valuation

Colorado is making significant strides in promoting employee ownership with a new bill that introduces substantial tax benefits and expands existing programs. Starting in 2027 and running through 2037, the legislation offers two key income tax subtractions:

  • Capital Gains Subtraction: Taxpayers who convert at least 20% of their qualified business to employee ownership can subtract the state capital gains realized from this conversion.
  • Worker-Owned Cooperative Subtraction: Worker-owned cooperatives can subtract their federal taxable income, up to $1 million.

Furthermore, the bill extends and enhances the existing tax credit for employee business ownership conversion costs. Key changes include:

  • Extending the credit through 2037.
  • Increasing the credit percentage from 50% to 75% starting in 2026.
  • Adjusting the annual aggregate credit limits to $3 million (2026-2031) and $4 million (2032-2037).
  • Expanding eligibility by revising definitions and allowing qualified support entities (nonprofits aiding conversions) to claim the credit.

These changes aim to incentivize business owners to transition to employee ownership, empower workers, and strengthen local economies by fostering a more equitable business landscape.

READ MORE

 

Plan, Lead, Flex, Repeat

Plan, Lead, Flex, Repeat

by | Mar 18, 2025 | ESOP Business Valuation, Estate and Gift Tax Business Valuation, SBA Business Valuation and Appraisal

Running a business during uncertain times can be challenging, but it’s not impossible. Changes in the economy, politics, unexpected events, and new technologies can make planning and successful operations hard. However, businesses that stay flexible and adapt quickly have a better chance of surviving and growing. To do this, business owners must be ready to change their plans and respond to new situations rapidly.

One key strategy is to review and adjust business plans regularly.  This includes thinking out contingency plans for unexpected but possible change.  Markets and customer needs can shift quickly, so businesses must keep an eye on trends and be ready to pivot (and you thought pivot ended with Covid) when needed. Being open to change allows companies to take advantage of new opportunities while limiting potential risks. Staying informed and making small adjustments over time can help businesses remain stable and competitive.

Another important factor is building a strong foundation. This means planning, building your balance sheet to survive emergencies, and ensuring business operations can continue even when problems arise. Building a management team that works together provides resilience and internal forums for problem-solving.  Companies should also have a variety of suppliers and customers to avoid concentrations that increase risk and can quickly put a firm out of business.  Planning can help companies to stay strong, even when unexpected challenges occur.

Finally, good leadership is crucial during uncertain times. Business owners and managers should communicate openly with their teams and encourage problem-solving. Employees who feel supported and valued are more likely to stay motivated and help the company succeed. Leaders should also take care of themselves, as making good decisions under pressure requires a clear mind.

With the right mindset and approach, businesses can not only survive tough times but come out stronger.

The Business Owner’s Path to an Accurate Valuation in 5 Steps

The Business Owner’s Path to an Accurate Valuation in 5 Steps

by | Feb 22, 2025 | ESOP Business Valuation, Estate and Gift Tax Business Valuation, SBA Business Valuation and Appraisal

You need a business valuation or a business appraisal.  You might need the business valuation for Estate and Gift business taxes, applying for an SBA loan, ESOP stock value, or a host of other reasons.  How can you make sure that you obtain the most accurate business valuation possible?

The business valuation is going to tell a story about your business.  This story will contain a narrative backed up by statistics, facts, and figures.  This story must make sense when it is complete.   Your job as a business owner obtaining a valuation is to make sure the story, facts, and figures are clear and sensible to the experienced valuation professional appraising the business.

Below are 5 steps business owners should take to make sure your business valuation is as accurate as possible.

THE 5 STEPS

  1. Be able to explain why your product or service is so desirable you can continue to make a high profit
    The most important thing in valuing your business is understanding how you create and keep a market of customers that will pay enough for your product or service that you can be expected to continue making a profit. Do you have patents keeping others out?  Do you have a unique distribution channel?  Do you have better internal systems and people?  This is the core of the business valuation.  How your business makes money and how it will continue to do so.  The ability to clearly and succinctly explain that is key to the valuer understanding your business and getting the valuation correct.
  2. Have quality financial information.
    You must have quality financial information. A business valuation is, to a large extent, a review of your past financial results and a projection of your future financial expectations.  Without clear data it is very difficult to see the details necessary to make correct assumptions and calculations.  In addition to historic financial information, business plans and useful projections consistently kept will add to the valuer’s understanding of the business.
  3. Have leases and major contracts in good order
    Leases, customer contracts, loan documents, and the like may not make a business, but if they are not in good order a business may suffer major losses quickly. These documents in good form reduce risk which increases value.  Have the major legal documents your business relies on updated and accessible, so you can provide them when asked.
  4. Have systems outlined and resumes of key people
    Simply put, a business is a series of systems that produce a product or service, hopefully at a profit.  Most businesses have many systems that are run by people.  True high-quality systems are where “normal people obtain extraordinary results every time.”  This requires great systems, great training, and very good people.   Make sure you can document all of these.
  5. Hire an experienced valuation professional.
    Clearly, the valuer must have the background to understand how actual businesses on the ground work and how that translates into value. Business valuations are performed for specific purposes – sales, SBA loans, ESOP structuring, divorce, Estate and Gift Tax.  While it might sound crazy, it is a fact that the purpose can often significantly change the correct business value found.  Make sure the valuer understands and has performed valuations for your purpose.  Finally, make sure they have sufficient background and training in the fundamentals of business valuation.

These five steps lead to a consistent well-run business and obtaining a correct business valuation.  Business valuation does have an element of the old saying, “garbage in – garbage out.” As a business owner you do play an important role in obtaining a proper business valuation.

The Role of Life Insurance in Estate Taxes

The Role of Life Insurance in Estate Taxes

by | Jan 21, 2025 | Estate and Gift Tax Business Valuation

The recent Supreme Court case, United States v. Connelly, has significant implications for businesses and their estate tax planning. The Court ruled that life insurance proceeds held by a company must be included in its valuation for estate tax purposes, even if those proceeds are earmarked for a stock redemption.

Imagine it this way: You have a house, and you have homeowner’s insurance that covers the replacement cost of the house. A similar ruling by the court would say the value of that insurance policy itself adds to the overall value of your house for tax purposes, even though it’s there to protect you, not increase your property value. We can all be relieved this is not currently true.

This ruling, however, is a game-changer for businesses. It means that life insurance policies held by a company are no longer considered “off the books” when it comes to taxes. So, businesses need to get creative to avoid a hefty tax bill down the road. It’s super important for owners and their advisors to review their buy-sell agreements and estate plans to make sure they’re still set up to minimize tax liabilities.

The good news? There are ways to work around this.

  • Different insurance setups: Instead of the company holding the insurance, owners can buy policies on each other, which can keep those payouts out of the company’s valuation.
  • Trusts: Putting insurance policies in a trust can also help keep them separate from the company’s assets.

Read More in Greg’s article for NACVA QuickRead: Valuation Lessons from Connelly v. United States