What Happens When . . . ? Why Are Family Business Leaders Deploying Buy-Sell and Business Continuity Agreements
How do today’s Family Business Leaders achieve lasting success? Whether instinctively or methodically, we see them asking and answering some version of essentially the following 3 Key Questions time and time again:
1. Discover. What will be the probable, almost certain, future outcome of our present course, if left unchanged?
2. Decide. What’s missing - the presence of which will make a substantial difference in producing a better future outcome?
3. Deploy. What do we need to do next to move ahead with speed, clarity and focus to deploy what’s missing?
Or, in short – they first look into their future, and to their Company’s future, and ask “What Happens When …?”
One of the most effective “Main Plays” being deployed by Family Business Leaders to address many “What Happens When . . . ?” situations is the Buy-Sell Agreement (which will sometimes go by a different title, such as a “Stockholders Agreement”).
The Family Business Buy-Sell Agreement
Every Owner in an American enterprise is free to transfer his or her shares to whomever he or she would like. And none of your fellow Owners are required to ever purchase your shares or sell theirs. Yet that can produce many undesired results. You could find yourself with partners you don’t want, and you could find yourself without the ability to sell your shares. So, how are Family Business Leaders fixing this?
A Buy-Sell Agreement is a critical planning tool for Family Business Leaders. This is an agreement amongst the Co-Owners of a Company which addresses the times and the terms for the future purchase or sale of partial or full ownership of a Company (whether a corporation, partnership or LLC). In a sense, this type of agreement is your own private stock market.
Unlike a public stock exchange, under your private stock market, you and other Co-Owners are not necessarily free to buy and sell stock to whomever you may please. However, this type of private stock market does create the ability to have some circumstances in which your shares can be purchased or in which you can cause the purchase of another Co-Owner’s shares.
This type of agreement also provides the ability to restrict Co-Owners from selling their shares to an outside party which the core Owners do not want to become Co-Owners with. In this sense, it also acts as a very solid protective measure for the business operations.
Buy-Sell Agreements are prepared based on the needs and objectives of the Co-Owners. Included below are some of the main types of situations which, along with proper price, payment terms and insurance funding, should generally be included, or considered for inclusion, in a Buy-Sell Agreement.
For Family Business Leaders who presently own 100% of their Company, we suggest a Standby Buy-Sell Agreement - so if you die and your family inherits your Company (as Co-Owners), you will have already “baked in” the ground rules for Company ownership.
What Happens When . . . Someone Wants To Sell? By including Transfer Restrictions, if an Owner wishes to transfer his or her shares to an outside third party, that Owner must first offer the shares either to the Company and/or to the other Owners for sale on the same terms and conditions that would be offered to the outside third party. This provides the Company and the other Owners with the option to purchase the shares, so you can retain ownership of the Company within the closely held group of Owners. Typically some exceptions would be made to this right of first refusal to enable Owners to transfer shares to their spouse and family members, as well as their Living Trust for Estate Planning purposes.
What Happens When . . . An Owner Dies? A “Purchase Upon Death” provision can operate in two ways. First, this can provide the Company (and the other Owners) with an option to purchase the shares of an Owner who has died. This provision can also give the Estate of the deceased Owner the option to sell (i.e. to “put”) the Estate’s shares to the Company (or the other Owners).
What Happens When . . . An Owner Is Disabled? A “Purchase Upon Disability” provision gives the Company (and other Owners) an option to purchase the shares of an Owner who has become totally disabled. This provision can also give the disabled Owner an option to sell the shares to the Company (and/or other Owners).
What Happens When . . . An Owner Stops Working? A “Purchase Upon Termination of Employment” provision will give the Company (and/or the other Owners) the option to purchase an Owner’s shares upon termination of employment. This may also give the terminating or retiring Owner an option to sell his or her shares to the Company (and/or the other Owners).
What Happens When . . . An Owner Declares Bankruptcy? A “Purchase Upon Bankruptcy” provision enables the Company to purchase the shares if an Owner was to declare bankruptcy. This helps to provide the Company with the option to disentangle itself from the personal financial problems of an Owner.
What Happens When . . . An Owner Gets Divorced? A “Purchase Upon Divorce” provision can provide that if an Owner is involved in a divorce from his or her spouse, and as a result of the divorce proceedings is not awarded the shares in the Company, then, to prevent disputes and business disruptions which might be caused by the marital separation, the Owner member of the couple who was initially issued the shares would typically have an option to purchase these shares from his or her spouse, with a secondary option to the Company (and/or the other Owners) if the first option is not exercised.
What Happens When . . . The Owners Want To Split Up? By using a “Texas Shootout” provision, the Owners are given the ability to each go their separate ways. This is more frequently included where you have roughly equal Owners. If an Owner wishes to separate, then he or she can make an offer to sell all of his or her shares to the other Owner upon stated pricing, terms and conditions (or this first offer can be to purchase).
The other Owner either must accept the offer, or refuse the offer, in which case, the initial offering Owner must purchase the shares of the declining Owner at the same price, terms and conditions initially offered.
What Happens When . . . The Majority Owner Wants To Sell 100%? A “Drag-Along” provision is used when a majority Owner or group of Owners wish to be able to sell the shares of the Company to an outside third party. Since an outside third-party would most likely want to be able to purchase 100% of the shares, this provision gives the majority Owners the right to require the minority Owners to sell their shares on the same price, terms and conditions which the majority Owner is receiving.
What Happens When . . . The Minority Owner Wants To Be Part of the Sale? Under a “Tag-Along” provision, a minority Owner would have the option to require that a majority Owner include the minority in a transaction for the sale of the shares of the Company. This would occur, for example, when the majority Owner did not exercise a Drag-Along option, but the minority Owner, nevertheless, wants to be included in the sale.
The Family Business Continuity Agreement
One of the other most effective “Main Plays” being deployed by Family Business Leaders to answer several other “What Happens When . . . ? situations is the Business Continuity Agreement.
Family Businesses, regardless of age and size, are often damaged or torn apart due to lack of a well-conceived system for avoiding and resolving disputes. These disputes can arise between Co– Owners, the spouses of Co-Owners and Co-Owner families.
The potential for disputes can become even more acute upon the death or disability of a key Owner (such as the founder). The role of a spouse or other family member may take on a new significance when the other Co-Owners attempt to work out issues with the spouse or family member who may not be familiar with some of the inner workings and understandings of long-term business partners.
In addition to issues regarding regular Company operations, disputes can arise as to how family salaries are to be set, how dividend distributions are to be determined and paid and who is to run the business as your successor. The risk involves not only adverse financial impact to the Company, but also can pose a threat to keeping peace within a family. Various matters which functioned well when you were around as the “traffic cop” to avoid or resolve disputes might no longer function nearly as well.
What Happens When . . . You Want To Avoid Disputes and Misunderstandings? In order to help minimize, avoid and resolve possible disputes amongst Co-Owners, spouses and family members, the Business Continuity Agreement is also being deployed by Family Business Leaders. This type of agreement operates in addition to a well-conceived Buy-Sell Agreement. The Business Continuity Agreement addresses issues other than Buy-Sell options and obligations.
The following are some of the features which we recommend be considered or included.
- Code of Business Conduct.
- Board-Level Approval Actions.
- Right to Engage In Competing Businesses.
- Confidentiality Provisions.
- Financial Statement Requirements.
- Subchapter “S” Protection.
- Tax Payment Dividends.
- Family Employment Policy.
- Family Compensation Policy.
- Share Redemption Program.
- Annual Dividend Policy.
- Non-Solicitation of Customers.
- Non-Solicitation of Employees.
- Board of Director Composition.
- Retirement Guidelines.
- Profit Strategy Team.
- Profit Plan Program.
- Company Formalities.
- Conflict of Interest Policy.
- Expected Retirement.
- Emergency Succession Plan.
The objective of the Business Continuity Agreement is to establish company guidelines, especially as they relate to Family Business Continuity issues. This Agreement, in effect, lets all of the players know what the rules are, but it retains the ability of the controlling Owner to change those rules as determined from time to time.
A Look Towards The Future
Hundreds of Family Business Leaders (and their Trusted Advisors) have trusted us to “look into the future” with them for a very specific reason.
Whether they are a startup or already well into many years with their business, they want to achieve remarkable success in all “Four Quarters” of their life as a Family Business Leader and Owner.
And they want to avoid the 24 Fourth Quarter “Train Wrecks” which derail even the best Family Business Leaders.
Our Family Business Continuity Team works with Family Business Leaders on achieving real world “Fourth Quarter” results. We are working together with today’s Family Business Leaders to grow, develop and strengthen Family Businesses throughout the U.S.
This all begins with understanding what you value most. And then moving ahead with speed, clarity and purpose to deploy what’s needed to stay successful throughout the whole game.
The Family Business Buy-Sell Agreement and the Business Continuity Agreement are two of the critical “Main Plays” being deployed to accomplish this.
For more information:
Download “The Ultimate Success Decision Guide for Family Business Leaders” at www.FourthQuarterFirst.com.
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