Buy/Sell Agreement Series: Part 2- Yes, You Really Do Need One

In the last issue of this newsletter, we presented a number of reasons why a business continuity (or buy/sell) agreement can be one of the single most important documents that you, as a closely held business owner, will sign.

Today we continue the discussion of buy/sell agreements by looking at how these agreements can protect rights among shareholders, provide a means for joint owners to clarify a common vision with regard to the future of the business, and establish a market for an owner’s stock at an agreed-upon price.

Buy/sell agreements establish and protect rights among shareholders that do not otherwise exist in the company

Through a buy/sell agreement, a minority shareholder may attain more control over his or her destiny than is normally provided through voting rights. These safeguards may include placing limits on the sale or purchase of the stock of the majority owner(s), establishing valuation of all owners’ stock, giving minority owners the right to sell their stock if certain events occur, and other important items.

An example of the type of right that a buy/sell agreement can establish is providing the owner of a minority interest the right to serve on the board of directors. This can be an important right because a minority shareholder might not otherwise be able to garner sufficient votes to be elected to the board.

A second example is requiring the corporation and remaining shareholders to do their best to obtain the release of the departing shareholder from any personally guaranteed indebtedness, as well as to release any personal collateral used for a corporate debt when the owner of that collateral sells his or her interest in the company. In difficult economic times you can expect banks and other creditors to be most reluctant to release personal guarantees and collateral without more than adequate replacement value.

In our last issue, we discussed the Tom Gardner and Acme, Inc. case study. As a minority owner, Tom was unable to buy control of the company and was unable to prevent a new majority owner from exercising total control over the company. A buy/sell agreement could have prevented that.

Buy/sell agreements force owner communication

In co-owned businesses, owners rarely sit down together to discuss their opinions about questions such as: What happens if one of us dies? What happens if we stop getting along? What happens if one wants to retire before the other? In order to create a buy/sell agreement, owners are forced to wrestle with these important questions.

Let’s look how this discussion played out for John and Steve, equal partners in a fictional manufacturing business.

John and Steve had a rocky relationship and so assumed that the other held opposing views about future growth of the business and about their respective desires to remain in the business. Like most co-owners, they each had their own opinion about their respective value to the company.

As avid readers of this newsletter, however, they understood that they needed a buy/sell agreement. It was while meeting with their advisory team to create a buy/sell agreement that they recognized the many reasons for their company’s success. Although John was the “money man” and Steve was more active in the business, they learned that both were equally concerned with the long-term future of the company. This recognition provided the foundation a buy/sell agreement drafted for their mutual benefit.

The drafting process took months. During that time, John and Steve met periodically with their advisors to review business goals and aspirations. Increasingly, they found common ground, not just in matters contained in the buy/sell agreement, but also with respect to operational ideas. Those bases of agreement soon broadened into a consensus on how the business should proceed if one of them were no longer with it.

As a result of this deliberative process, Steve and John became more committed to the business and, not coincidentally, the company’s profitability and value increased steadily.

A buy/sell agreement establishes a market for an owner’s stock at an agreed-upon price

Without an agreement, there’s no market for stock in a closely held business, even if you’re a controlling owner. Your ability to sell your interest will be limited unless you can require your co-owner to also sell. (Most buyers want to own 100 percent of a company and don’t want the potential “excess baggage” of a co-owner they didn’t choose.)

If you have not made firm arrangements for the sale of your stock, the buy/sell agreement is the only means of disposing of your ownership interest at a fair price. The agreement can obligate other owners to purchase your stock, thus creating a market if you must sell your stock due to unforeseen events such as death or disability.

There are many advantages to a buy/sell agreement. In our next two issues, we’ll talk more specifically about the problems that business continuity planning can surmount.

If you have any questions about how to talk to your co-owner about creating a strong business continuity agreement for your company, please contact us to discuss your particular situation.

Take care and have a good day,

Michael

ABOUT LEGACYHP: Our passion is our mission -- To position our clients into a positive, energized, posture -- within your businesses and within your lives -- So that you manage change confidently, take decisive action, and enjoy life's journey Today... while you enjoy building your Legacy for Tomorrow.

Notice: The information contained in this article is general in nature and is not legal, tax or financial advice. For information regarding your particular situation, contact an attorney or a tax or financial advisor. The information in this newsletter is provided with the understanding that it does not render legal, accounting, tax or financial advice. In specific cases, clients should consult their legal, accounting, tax or financial advisor. This article is not intended to give advice or to represent our firm as being qualified to give advice in all areas of professional services. Exit Planning is a discipline that typically requires the collaboration of multiple professional advisors. To the extent that our firm does not have the expertise required on a particular matter, we will always work closely with you to help you gain access to the resources and professional advice that you need.