Why Every Professional Service Firm Needs a Buy-Sell Agreement

Why Every Professional Service Firm Needs a Buy-Sell Agreement

Navigating the world of business partnerships is both thrilling and challenging. Whether you’re the co-founder of a consulting firm, a marketing agency, a software development firm, or another type of service firm, the common denominator for ensuring long-term harmony and clarity in ownership matters is a well-drafted buy-sell agreement.

Purpose of Buy-Sell Agreements

A buy-sell agreement is akin to a prenuptial agreement for business. It preempts potential disputes by delineating terms and conditions under which a partner can sell their stake, to whom, and at what price. The key purpose is twofold:

    1. Providing Liquidity: Businesses, especially boutique professional service firms, are often illiquid assets. This means if a partner wants to exit, they can’t easily convert their ownership into cash. A buy-sell agreement offers a solution by laying out the terms and conditions under which such an exit can occur, ensuring the departing partner receives fair compensation for their shares.

    2. Limiting Ownership: These agreements ensure that ownership remains within a controlled, desired group. Without them, partners could potentially sell their shares to anyone, which may not be in the firm’s best interest.

Three Key Provisions of Buy-Sell Agreements:

    1. Establishing Transfer Permissions: At its core, a buy-sell agreement mandates that any transfer of shares requires the unanimous consent of co-founders.

      Illustrative Example for Consulting Firms: Let’s say Alex and Jamie co-founded a thriving management consultancy. Alex receives an attractive offer from an external investor to buy half of his shares. With a buy-sell agreement in place, Alex cannot sell without Jamie’s approval. This protects the business from unwanted or potentially disruptive external investors.

    2. Restricting Share Transfer: This provision determines who can buy shares and under which circumstances, ensuring that the firm’s ownership remains within the desired group.

      Illustrative Example for Marketing Agencies: Consider Maria and Jennifer, who co-founded a marketing agency. Their buy-sell agreement stipulates that shares can only be sold to existing partners or family members. Jennifer wants to retire and sell her shares to a close friend who’s a marketing whiz. Although the friend is talented, the buy-sell agreement restricts this sale unless Maria consents.

    3. Obligatory Purchase at Fair Value: This provision ensures that, upon certain trigger events (like death, disability, or retirement), one party must buy, and the other must sell the shares at a predetermined or fairly computed price.

      Illustrative Example for Software Development Firms: Matt and Roberto run a software development firm. If Roberto were to suddenly pass away, their buy-sell agreement might require Matt to buy Roberto’s shares from his heirs at a previously agreed upon price or a price determined by a valuation formula. This ensures that Roberto’s family receives fair compensation and Matt retains full control of the business.

Facilitating the Buy-Sell Discussion:

Creating a buy-sell agreement requires open dialogue among partners about their visions for the firm’s future, their personal financial needs, and their potential exit scenarios.

Tool for Discussion: The “Partnership Alignment Matrix”

    1. Vision for the Firm: Have each partner separately list out where they see the firm, and themselves, in 5, 10, and 15 years. Compare notes. Are you aligned?

    2. Potential Exit Scenarios: List out reasons each partner might exit (e.g., retirement, other business opportunities, health issues). Discuss and prioritize them.

    3. Valuation Mechanisms: Discuss how the firm should be valued in various scenarios. Use industry metrics, get periodic professional valuations, or set a fixed price that’s revisited annually.

Meeting with a mediator or a neutral third party can also be valuable during these discussions to ensure that all concerns are addressed. Here are a few Collective 54 members who can help you think through a buy-sell agreement:

Greg Fincke

Tom Zucker

Frank Williamson

Rick Sapio

In conclusion, while the thrill of starting a boutique professional service firm can overshadow future-focused planning, it’s crucial to prepare for all eventualities. A buy-sell agreement is an indispensable tool that safeguards the firm’s future, provides clarity, and ensures the financial well-being of all partners. Always consult with an experienced attorney when drafting or revising such an agreement.

Waiting too Long to Sell

Waiting too Long to Sell

Play Video

There’s a good time to sell your firm, and there’s a bad time. But how do you know when it’s the right time to exit?

Watch this video and discover the environmental factors that play into selling your firm, the value of knowing what’s happening in your niche, and how to prevent a situation where you’re forced to sell.

In this video, you’ll also learn:

    • 5 environmental factors that play into selling your firm
    • Why you need to understand deal activity in your industry
    • How to identify if your firm is sellable
    • The importance of landing your firm in an existing category