We’ve all heard the stats… 50% of marriages end in divorce. And you ask, what does this have to do with business law Scott? The answer is simple, despite the myth that 95% of companies fail (I’ve heard, 80%, 90%, etc.), reality suggests that nearly 50% of companies make it to the fifth year. ( https://www.sba.gov/sites/default/files/Business-Survival.pdf). Precisely why we recommend business buy-sell agreements to many of our clients.
The Buy-Sell Agreement (“BSA”) is most useful in multi-member (2 or more) businesses. It creates an exit plan for the owners if certain issues arise. These issues, often referred to as triggering events, can be almost anything. Commonly, we see them arise as: deadlocks on decisions, death, divorce, termination of employment of an owner, sale of a majority of interest in the company, disability, conviction of a serious crime, bankruptcy, retirement, and more.
The reality, if a business makes it to, or past, the fifth year, it will likely face one or more of these issues. Unfortunately, many business owners have no idea what will happen if such an event occurs. Therefore, the owners resort to litigation as the only way out.
What does a BSA Protect Against?
The best way to describe how a buy-sell agreement works, is through examples. Here is a quick one.
ABC, LLC is owned by Joe and Bob, 50% each. Joe is a widower and has three children (18, 22, and 24). Bob is married and has two minor children. Joe and Bob started the company 10 years ago and it is currently valued at $5 million. Joe and Bob used an internet document service to form the company and never heard of a BSA. Unfortunately, Joe passes away suddenly in a freak cliff-diving accident. Joe left all his assets outright to his three children in equal shares.
In this example, Joe’s three children each gain 1/3 of Joe’s membership interest in ABC, LLC. Bob now has three new partners. Each of whom demand their dividend split and desire to work at ABC, LLC with all the perks (pay and benefits) Joe had during his time with the company. None of them have a degree or any knowledge of the business. Needless to say, Bob is at his wits end.
How a Buy-Sell Agreement Can Help
With a properly drafted BSA, Bob could have avoided this disaster. His attorney would have likely recommended Joe and Bob take out life insurance and disability insurance. The insurance would have been sufficient to cover each partners’ membership interest. Upon Joe’s death, Bob would have received the $2.5 million life insurance policy. Quickly, Bob has enough cash to fund the purchase of Joe’s 50% of the company based on the terms of the BSA. Bob would become the sole owner of ABC, LLC and avoided the many potential issues created by having three new partners.
If you have never heard of a buy-sell agreement, it may not be too late. You can see our 25 Point Buy-Sell Agreement Checklist here. Or give us a call if you have additional questions or are ready to get started protecting your business.