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. (see, https://www.sba.gov/sites/default/files/Business-Survival.pdf). So businesses are a lot like marriages, and like any partnership, there are a lot of reasons they fail and a lot of ways for outsiders to make a positive or negative impact.
The Buy/Sell Agreement (“BSA”) is most useful in multi-member (2 or more) businesses and it creates an exit plan for the owners if certain contingencies arise. These contingencies, often referred to as triggering events, can be almost anything: deadlock on future business plans, 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 is most small businesses that make it to, or past, the fifth year will face one or more of these issues and the owners have no idea what will happen if such an event occurs. (to keep it simple, this typically = litigation)
Let's see how this plays out in an example. 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 passed away suddenly (he was a semi-pro cliff diver after all), leaving 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.
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 sufficient to cover each partners’ membership interest. Then upon Joe’s death, Bob would have received the $2.5 million he needed 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.
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.