Buy Sell Agreements…An Often Misplaced Document
Misplaced is often a substitute in business owner lexicon for “I have not reviewed my buy sell since it was written”. In one case a motorcycle dealer we interviewed had lost two of his fellow shareholders in one afternoon in a tragic bicycling accident and could not find his buy sell agreement nor could his attorney. Relying on memory when dealing with grieving spouses, girlfriends and children is not a recommended business practice.
Where is your buy sell, is it buried in your operating agreement for your LLC, or is it in a file in a drawer not opened in years? For those of you who are up to date with your agreement, the above scenarios would seem unthinkable. However, years of experience in asking business owners “ How long has it been since you reviewed your buy sell agreement with your partners?” only to be met with a vacant look has taught me this is too often a “misplaced document”.
What is a buy sell agreement and when is it used? In many cases it is the second most important document for a business owner second only to wills and trusts. Why you may ask? Because if designed correctly, it defines triggering events such as death, incapacitation, disagreement or divorce, what is going to happen to stock or interest in an entity, how much will be paid for the interest being transferred, the conditions of the payout, when it will occur and the funding vehicles that are in place. All very important pieces of information to a grieving widow or for the widow’s attorney.
Now, knowing what a buy sell does, doesn’t it make sense to review this document at least annually to answer three questions: does this document still meet current objectives and is the value assigned to the interest it represents a fair representation of its true value? The third question is if one of the triggering events occurred today, are the funding vehicles in place adequate to avoid the payout from disrupting the growth of the business?
Buy sells are often almost an after thought during the formation of a new business. Too often they are standard documents without much thought or customization. The following story displays the importance of thinking through the situations being addressed and working with an attorney and planning advisors to customize the buy sell document.
A client who owned a very successful plastics pipe manufacturing operation which was owned 70% by the founder, and 10% each by two sons and a non-family key employee. One son and the non-family key employee were single and the older son was married to an attorney. The company was valued at 15 million based on years of steady seven figure earnings.
The majority owner father wanted to establish a buy sell agreement triggered by the younger single son joining the business. During the lengthy process of creating their agreement, the father insisted that there be a clause in the contract requiring all minority owners to have a pre or post-nuptial agreement that stated that the spouse was giving up all rights to the stock in the company. His thinking was driven by a worry about the life style of his younger son and the choices he was making, and his desire to protect the company from predatory demands. If no pre or post nuptial agreement was on file with the company, that party would be forced to sell their stock back to the company at a discount.
The buy sell was eventually signed by all parties. The married son and his spouse engaged in a process with her attorney to assure their agreement would withstand any legal challenges. There was some back and forth negotiations, but she understood that her father-in-law was protecting the business he had created, and the post-nuptial was executed and put on file.
Two years later I received a call from the father requesting a breakfast meeting the next day. At breakfast he revealed that son number two had announced his engagement and intention to marry. Dad, acting on a hunch, hired a private investigator who discovered that she was employed at a local bar as a stripper. He expressed his suspicions that she might not be marrying just for love. He asked if the pre-nuptial requirement was still a part of the buy sell agreement. I assured him it was and showed him the wording.
This was a Thursday morning, and he had a meeting scheduled with his son and his fiancée later that day. He intended to inform them of the pre-nuptial requirement which he intended to enforce and that he wanted a signed pre-nuptial by the close of business the next Monday. If not he would purchase the stock back from his son at a heavily discounted value. Dad eventually relaxed the time frame, but within a couple of weeks there was a signed pre-nuptial agreement that would stand up to any legal challenge.
The father’s suspicions proved to be true as it was discovered the new wife was bringing $38,000 of credit card debt into the marriage, not disclosed prior, and continued to be a “ wild child spendthrift”. Things went from bad to worst, and after two very difficult years they divorced. The pre-nuptial was questioned but not challenged in the divorce proceedings.
The son had turned to serious drug use during the marriage. The family essentially rescued him from his dark place and brought him home. Attempts at rehabilitation from his depression were met with spotty results and tragically a year later he took his own life further devastating his mother and father.
This is a sad story on so many levels, the premature loss of a family member was heart breaking, but the fact that the father insisted that the buy sell be customized with pre and post nuptial requirements likely saved him and the company from difficult and expensive litigation during the divorce settlement which would have likely been a further distraction. Ultimately it may have saved the company.
Buy sell agreements can be powerful planning instruments to implement a family’s wishes regarding the preservation of their business and seeing their family’s shared vision realized. The question all business owners should ask themselves: “Is my buy sell agreement a ‘misplaced document’”?
Bill is a partner with Aspen Family Business Group. For over 35 years, Bill has devoted his career to the service of others in the area of wealth transition planning. ( view bio )