My advice to lawyers and CPAs is to prepare your clients for the prospect of a business divorce. A business relationship is no different than a marital one; people change, circumstances change, and people grow (and don’t grow) in different directions. And by “preparing for a business divorce,” I am referring to the need to create an operating agreement from the outset of a business relationship to address the following issues, if and when they arise:
- Death of an equity owner;
- Disability of an equity owner;
- Sale of an equity interest to a third party;
- Termination of an equity owner’s employment; and
- The subject of this article: the predetermined steps to value an equity interest.
When a new business begins, financial resources are usually devoted to its tangible needs, while intangible needs are usually delayed. An operating agreement is typically recognized as an intangible need that can wait until cash flow improves. I, however, advise both new and newer business owners to negotiate the terms of an operating agreement as early in the business life cycle as possible, as once issues develop, it will be too late to negotiate a mutually acceptable operating agreement.
