A Guide to Understanding RIA Buy-Sell Agreements

Buy-sell agreements are essential legal contracts that dictate the transfer and sale of ownership interests in a business in the event of specific triggering events such as the death, disability, or retirement of an owner. For RIAs, these agreements play a crucial role in establishing a framework for ownership transition and succession planning, ensuring the continuity and stability of their firms. This article aims to provide an overview of RIA buy-sell agreements, addressing what buy-sell agreements are, why they’re important for RIAs, the key elements of such agreements, and common mistakes RIAs make with respect to such buy-sell agreements. For a more in-depth discussion on best practices for internal succession planning, please click here.

What is an RIA Buy-Sell Agreement?

An RIA buy-sell agreement is a binding agreement that outlines the terms for buying and selling ownership interests in the advisory business. Its main purpose is to establish a clear framework for ownership transition when certain triggering events occur. These events typically include the death, disability, retirement, voluntary departure, or expulsion of a partner or owner.

RIA buy-sell agreements take several forms. For some RIAs, they are specific provisions in the operating or partnership agreement of the RIA that outline what happens to the equity ownership of an owner who dies, becomes disabled, retires, voluntarily withdraws, or is expelled from the firm. For others, they are stand-alone contingency agreements whereby the buyer agrees to purchase from the seller the seller’s ownership interest in the RIA, but only in the event of the seller’s death, disability, or retirement.

Why are Buy-Sell Agreements Important for RIAs?

There are at least four reasons buy-sell agreements are important for investment advisers.

First and foremost, they ensure that clients will continue to receive the services they need should something happen to the selling advisor. Such agreements help to maintain confidence and trust among clients by assuring them that their investments will continue to be managed by a competent and experienced team. This could also be important to new clients who are looking to sign on with the RIA as new clients.

Second, buy-sell agreements mitigate confusion among firm owners. Investment advisory firms are not immune to internal conflicts among partners or owners. A well-structured buy-sell agreement can help prevent or resolve such disputes by establishing clear guidelines for transferring ownership interests. By providing a predetermined mechanism for addressing changes in ownership, these agreements promote a more harmonious work environment, allowing the firm to focus more attention on clients’ needs.

Third, buy-sell agreements could be perceived beneficially by those looking to invest in the equity of RIAs. The existence of such buy-sell agreements helps investors to gain confidence that their investment in the RIA will be protected should something happen to the key persons of the firm.

Fourth, buy-sell agreements can help in the recruitment of new employees or advisors as they can generate confidence with respect to the long-term viability of the RIA firm’s business.

What are the Key Components of a Buy-Sell Agreement?

There are at least four key components of any buy-sell agreement.

First, they define the triggering events that would initiate the process of buying or selling ownership interests. It is essential to clearly define what these triggers are and set parameters to avoid ambiguity and potential conflicts. For instance, it’s vital to determine what constitutes a “disability” that would trigger the need for the sale of an owner’s interest.

Second, buy-sell agreements define how the purchase price will be calculated with respect to the sale of an ownership interest upon a triggering event. RIAs have several valuation methods at their disposal, such as book value, earnings multiples, or independent appraisals. The chosen approach should align with the firm’s specific circumstances and balance the interests of the buying and selling parties.

Third, buy-sell agreements define other key terms relating to the purchase, including the date on which the valuation takes place as well as the timing for the payment of the purchase price (e.g., how much of the purchase price is paid upfront at the closing and how much is paid in installments over time).

Fourth, buy-sell agreements often define how the purchase price will be financed, if applicable. This issue requires careful consideration to ensure that there are sufficient financial resources available when a triggering event occurs. Common funding mechanisms include life insurance policies, installment payments, or external financing. The chosen strategy should align with the business’s financial capabilities and long-term goals.

What are the Most Common Mistakes RIAs Make with Buy-Sell Agreements?

There are at least three common mistakes RIAs make when it comes to adopting and implementing buy-sell agreements.

First, RIAs sometimes make the mistake of failing to clearly think through and define the key terms of buy-sell agreements. Ambiguity can lead to disputes down the road and potential harm to the RIA firm’s business. Therefore, it’s vital for RIAs to consult an attorney who can help think through the key terms that must be clearly-defined in any well-crafted buy-sell agreement.

Second, some RIAs fail to revisit their buy-sell agreements after they’ve been adopted. The reality is that the RIA business changes over time, and so do the circumstances and needs of the owners. This is why it’s vital for owners to periodically revisit the buy-sell agreement to ensure that it continues to reflect the terms they want to govern any buy-sell transaction in the future.

Third, some RIAs fail to give sufficient consideration to the need for buyers to obtain financing to effect a buy-sell transaction. Insufficient financial resources to fund the purchase of ownership interests can pose significant challenges when a triggering event occurs. RIAs must carefully plan and implement appropriate funding strategies to ensure they can fulfill their obligations under the buy-sell agreement. Considerations should include life insurance policies, installment payment plans, or external financing arrangements.

Conclusion

Buy-sell agreements are not just mere legal documents; they are vital tools for RIAs to ensure a smooth transition of ownership, protect client interests, and maintain firm sustainability. By understanding what buy-sell agreements are, why they are important, the key elements involved, and the common mistakes to avoid, RIAs can secure the long-term success of their businesses. The careful crafting and regular review of buy-sell agreements will help RIAs navigate potential ownership transition events and maintain stability in an ever-changing industry.