Buy-Sell Agreement: I Wish I Had One When…

August 31, 2016Exit Strategies, Family Business, Succession Planning

Everything will turn out 100% as I expected. This partnership, despite the insurmountable odds, will succeed. Everyone’s marriage will never end in divorce. Those staggering statistics stating how 80% of partnerships fail and 50% of marriages end in divorce don’t apply to my partner or me. We’re both incredibly healthy. We will live out until old age.

That sounds unlikely, doesn’t it?

That’s because it is. Despite perpetual optimism in partners starting a new business venture, life always happens. Death, divorce, disability, and departure will eventually impact the business in some form.

Unfortunately, the vast majority of businesses don’t have comprehensive buy-sell agreements in place to account for the countless life factors that impact a business. What started out as an exciting venture where everyone wanted to ensure the success of the business ends in bitter legal arguments, malicious maneuvers, ruined family relations, and destroyed businesses.

Consider if you had a $10 million company run by a father, daughter, and two son team. Each owned 1/4, leaving no majority owner. As they are family, there is no need to put any mechanisms in place to address potential fallouts or deaths.

Or is there?
 

Death

Dad has a heart attack. It’s sudden, unexpected, and takes him quickly. He has no trust or buy-sell agreement in place.

His entire estate is distributed through probate. A diligent father and husband, his 25% share of the business is now his wife’s. At first glance, this appears that it will be smooth sailing.

There is one important caveat. His current wife is the stepmother to the three children.

To complicate matters further, the children do not get along with their stepmother. She wants her $2.5 million of share value of the business but the kids insist they don’t have the money.  They have controlling interest in the company, no money to buy back their dad’s shares and now an unwelcome partner on the board.

Without any sale proceeds or company dividends, the stepmother doesn’t see a dime.

Now the entire family is involved in a giant feud regarding what Dad would have wanted. When the siblings do decide to settle the account after three years of fighting, emotional name-calling and the aggravation of legal bills, they offer the stepmother a significant discount. Without alternative options, such as a life insurance funding mechanism or any buyers in the market, the stepmother has limited options.

It’s safe to assume this is the last thing Dad would have wanted following his passing.
 

The Alternative

A proper buy-sell agreement would have outlined the steps in case of death.  Conversations prior to the death would have allowed for open dialogue and communication with all family members. Even more importantly, they could have had life insurance in place to pay for the untimely death. Since death is considered an involuntary exit, most buy-sell agreements would have been drafted to award the stepmother the full value of her shares verses a minority discount. Rather than requiring the money come out of the business, common death clauses involve purchasing life insurance on all of the owners. Upon their death, the life insurance payout settles the estate.
 

Disability

The son has a motorcycle accident.

Unfortunately, he is in a coma. With him no longer being able to work, it raises the question of how to address his 25% of the company. How long do the three remaining partners pay his family a salary? How does the company afford to pay him while hiring his replacement? After hiring his replacement, this stretches the budget. What is the trigger point where the company has to buy the shares from his wife? To do that, they have to consider whether they pay full value for minority shares, and then if it will be paid over time or in a lump sum.

During the months following the accident, the father disagrees with how his daughter-in-law chooses to manage his son’s medical treatment. This leads to a fight, which further delays the son’s family receiving an answer on how the business will address the situation. Without any legal options, the son’s wife appeals to the daughter. This adds further strain to tense family relations.
 

The Alternative

Buy-sell agreements vary regarding how they address disability. Some businesses purchase disability insurance to buy out the disabled partner. Others create distribution plans. The main point is that they create a specific game plan on how to proceed, should one of the partners become disabled. This outlines actions for both long-term and short-term accidents.
 

Departure

The daughter wants out of the business.

In short, she doesn’t feel valued and is looking to start her own venture. She wants her $2.5 million in cash now to launch her new business. Bitter about her leaving and questioning her worth to the business, the brothers don’t believe she deserves a cent from the business. They believe Dad overpays her as is. Additionally, the company can’t afford the valuation. They argue her valuation should be based on her minority interest in the company, ultimately discounting the final payout.

Already partially retired, Dad tries to stay out of the fight.

Without any specific terms defining a voluntary exit, the three siblings go after each other to force the other’s hand. This starts with suing each other. Liquidating the assets follows. Each rapidly tries to buy them up to prevent the other from controlling them. Any profits or reserves from the business go to attorney fees.

Without cash and suffering neglect, the business flounders. At home, all family relations quickly deteriorate beyond repair.
 

The Alternative

A buy-sell agreement sidesteps this entire emotional, business, and relationship disaster. Clearly outlining exit terms, a common agreement clause could have stated that the business be valuated prior to the daughter’s departure. In order to deter an exit, she will have a 20% minority discount on her shares. The business won’t have to pay the $2 million for five years, with the entire sum to be paid off in ten years. Much like a loan, the business will pay a 5% interest rate until the amount is paid in full.

While the first Thanksgiving dinner may be awkward, over time the three siblings will still have a chance to repair their relationship.
 

Divorce

Dad goes through a shaky time in his marriage. He decides to separate from his spouse. He and his wife look at the complete estate value. The business shares are now on the negotiating table, both in value and in control. The soon-to-be ex-wife sees the success of the business and wants 50% of his shares.

As the marriage pulls apart, the sons and daughter realize they now have their ex-stepmother as a 12.5% owner of the company.

To prevent that scenario, they decide to create a buy-sell today.

They bring all four partners together and outline the new agreement. Typically, upon divorce with a buy-sell agreement, the spouses would be forced to give up the business shares. They would be able to include the dollar value of the shares in the settlement. This would mean that the wife would be able to get the house or the boat, but not the business shares. This way, the business shares stay with the business owners. The partners remain partners without unwanted ownership.
 

The Alternative

Creating the buy-sell terms in case of divorce is much better when the business is just starting off or still early. The business value has not been created, the mixture of business and personal values is still young and is much easier with the respective spouses. All four partners can see the challenge of having an ex-spouse owning shares of the company. Without the emotions and historical baggage from ten to twenty years of running the business, the owners can outline an agreement that represents the best interest of the business.
 

Creating a Buy-Sell Agreement Today

Exit Consulting Group sees these types of scenarios play out every day. Countless families, who five to ten years ago would have never said an ill word about each other, hire expensive lawyers to mitigate vicious feuds. Best friends who enter a partnership don’t realize the implication spouses play. Decades later, they are subject to the madness of the minority ownership of a malicious ex.

Life happens.

The key is to plan for it when the partnership is just beginning. If the business has already been around for several years, it’s essential to create a buy-sell agreement while things are still good. Not doing so only leads to disaster.

If your company is currently operating without a buy-sell agreement, contact us at Exit Consulting Group today. We help organizations with multiple partners facilitate the dialogue around value so a qualified attorney can draft the agreement. Oftentimes this includes helping navigate the complex emotions, family dynamics, and historical context that plays into establishing value.

Don’t wait until one death, divorce, disability, or a departure threatens the stability of your business.