These are vital instruments for AEC companies to ensure smooth transitions and business continuity.
In the AEC industry, buy/sell agreements are essential tools to ensure business continuity and stability. These agreements are pivotal in facilitating seamless ownership transitions and safeguarding the interests of all parties involved. The 2024 Principals, Partners & Owners Report of AEC Firms is a comprehensive study of owners and top managers of AEC firms and it touches a good deal on buy/sell agreements.
Why is a buy/sell agreement so important? Of the surveyed participating principals, only 73 percent said they had structured buy/sell agreements. That number should be 100 percent.
Imagine the buy/sell agreement as a pillar. It supports the most crucial and sensitive circumstances that can happen to a firm. The buy/sell agreement lays out in great detail how the firm will proceed if an owner decides to withdraw, retire, sell their interests to someone else, get a divorce, or passes away, it protects the remaining owners’ interests by setting the price and terms for a buyout. It’s a safety net. In case unforeseeable circumstances occur, it is there to provide stability and support.
Without one, you’re basically driving the business without a roadmap and legally navigating diverse scenarios is next to impossible. For example, consider the following scenarios:
- If a firm owner passes away unexpectedly, and the firm has no buy/sell agreement, there is no clear understanding of how to value the deceased owner’s shares. This will elongate the process of the deceased owner’s estate of receiving that value.
- If there is an owner who voluntarily leaves the firm due to some disagreement and there is no buy/sell agreement in place, the owner who left can still be an owner despite not working at the company. A good buy/sell agreement spells out a mandatory purchase and sale of the former owner’s interests upon leaving the company.
Basically, having a buy/sell agreement in place provides certainty and protection. Picture a family-owned business where the father and son are co-owners. They have a buy/sell agreement that allows for a smooth transition of ownership in case of disagreements or retirement. If the father decides to retire early and sell his shares, the agreement outlines clear procedures and terms for the buyout. This prevents any family disputes and costly litigation by providing a structured process for resolving ownership changes.
Types of buy/sell agreements. Here are three of the most common types of buy/sell agreements typically entered into by AEC companies:
- Cross-purchase agreements. This is a popular choice among AEC firms with multiple owners. In this arrangement, each owner agrees to purchase the shares of a departing or deceased owner. Typically, life insurance policies are used to fund these buyouts, with each partner owning a policy on each of the other partners. This type of agreement helps maintain the existing ownership structure and ensures that the business remains within the group of original owners. This agreement works best for three or fewer owners.
- Stock redemption agreements. These agreements are another widely used type of buy/sell agreement, particularly attractive for corporate AEC entities. Under this arrangement, the company itself agrees to buy back the shares of a departing or deceased owner. The firm may use corporate funds or life insurance policies to facilitate this purchase. One significant advantage is that it simplifies the transaction, as the burden does not fall on individual owners to buy out the shares. This agreement is normally the best option for three or more owners.
- Hybrid agreements. As you would imagine, hybrid agreements combine elements of both cross-purchase and stock redemption agreements. Initially, the company has the first option to buy the shares. If the company declines or is unable to make the purchase, then the individual owners have the opportunity to buy the shares. This flexibility ensures that there are multiple avenues for completing the buyout, providing a robust safety net for the continuation of the business.
How to get started. If you don’t have a buy/sell agreement in place, but would like to develop one, where do you begin? What are the necessary elements that a buy/sell agreement should have?
Since the AEC industry is so unique, working with a lawyer who serves only the AEC industry is essential because they will be familiar with what works best for AEC firms. The buy/sell agreement must have buy-sell provisions that are tailored to fit the needs of each firm. They describe events and related procedures for when owners are permitted or are required to buy or sell interests from each other.
All buy/sell agreements should have the following: general background of the firm, specific triggering events, purchase price, and payment terms.
Overall, buy/sell agreements are vital instruments for AEC companies to ensure smooth transitions and business continuity. Choosing the right type of agreement depends on the specific needs and structure of the business, as well as owner preference.
Ezequiel Tovar is an analyst within Zweig Group’s ownership transition team. Contact him at etovar@zweiggroup.com.
