Buy Sell Agreements-a true story
Not long ago, we received a referral from an insurance professional. He told us a very good client of his needed exit planning. He said the two co-shareholders in ML HVAC, Inc. a construction-related company had a buy-sell agreement, but it was out of date and the older partner wanted to retire in the next five years.
The insurance agent was originally called in to replace the term insurance the owners had purchased 20 years ago to fund their buy-sell agreement. The older partner, Moe, was in his early 60's and wanted to retire in the next 5 years, and the younger partner, Larry, was in his late 40's. The agent called us, because it sounded like Exit Planning would address not only the buy-sell agreement, but also the other issues related to Moe selling his share of the business to Larry.
We spoke with Moe to learn more about their situation. He told us that he and Larry had executed this buy-sell agreement when they began the company. They each purchased $150,000 of 20 year term life insurance to fund the agreement should either shareholder die. When we asked if the company had increased in value over the last 20 years, Moe said that it had. After this brief phone conversation, Larry and Moe agreed to meet with us, if not to discuss the broader issues of exit planning, at least to address their buy-sell agreement.
When we arrived, Larry opened the safe and pulled out the agreement. The first thing we saw was a boilerplate insurance company buy-sell agreement-one that insurance companies provide to their agents to use as a conversation starter. Across the top, it said "SPECIMEN DOCUMENT." We've seen these used with the blanks filled in by the partners and executed by the parties, but that wasn't the case with Larry and Moe. "No," Moe told us, "That one was too complicated, so we wrote our own. Here it is." What he showed us was a single page. We knew it was a buy-sell agreement because that's what was written across the top of the paper. Other than that, there was no indication in the body of the document that it was, in fact, a buy-sell agreement. There was no mention of the purchase or sale of stock. It did address the disposition of life insurance proceeds upon the death of either partner, but not in exchange for shares of the company. In fact, the policies referenced in this piece of paper were owned by Moe and Larry individually with the company as the beneficiary.
When we explained that the document, which they had written themselves, did not bind either party to buy or sell and that it was really an invitation for the surviving spouse to litigate, Moe and Larry said in unison:
"That would never happen!"
They explained to us that besides being business partners, they and their families were the best of friends-they raised their kids together, travelled together and celebrated holidays together. What they refused to understand is that no matter how close partners are both professionally and personally, when money is at stake, friendship can easily fall by the wayside. In these situations, the surviving spouse ALWAYS has an attorney named Curly who is going to vigorously advocate for her interests. In the 20 years Moe and Larry had been together, the value of ML HVAC had grown from nothing to over $2,000,000. Even if the buy-sell was set up properly, the life insurance funding of $150,000 would barely make a dent in buying the stock from the surviving spouse.
In a case like this, with $1,000,000 at stake for the surviving spouse, the legal fees could be hundreds of thousands of dollars, eating up a huge chunk of the value of the company and crippling the surviving owner. We urged Moe and Larry to spend a few thousand dollars in legal fee NOW in order to avoid risking huge legal fees if this nightmare scenario were to occur.
But not all clients take your advice. Moe and Larry didn't. They didn't engage us to work with them on the exit planning, nor did they see the attorney we recommended to prepare a real buy-sell agreement.
Why do business owners procrastinate when it comes to their buy-sell agreements?
Ø Because the first "triggering event" people think of in a buy-sell agreement is death. Owners shy away for the same reason they do so from doing their wills and estate planning-they don't want to face their own mortality. GET OVER IT. If you co-own a business, not having a buy-sell is probably the most irresponsible thing you can do to your family and to your partner. More importantly, death is not the only triggering event that needs to be included. These are some of the issues which must be considered:
o Disability/Incapacity
o Divorce
o Personal Bankruptcy
o Desire to sell
o Irreconcilable differences
Ø Agreeing on these terms can be difficult and emotional. GET OVER IT. If you think it's hard now, imagine how it's going to be for your surviving spouse...OR...Don't wait until you're going through a divorce and have no bargaining power because you must sell your shares to provide liquidity in a divorce settlement
Ø You are too busy. MAKE THE TIME NOW, or your family will pay the price for years.
Ø You don't want to spend the money. You can see how going cheap is going to work for Moe and Larry. GROW UP. PAY A PROFESSIONAL.
A Buy-Sell agreement is one of the most important documents that co-owners of a company can have. It is an instruction manual for how to operate the company and to handle the ownership interests after the occurrence of triggering events which should be clearly defined in the document. It is easy and inexpensive to set up. Yet many business owners simply fail to move forward as they are swept away with the routine activities of the business.
Send this article to everyone you know who co-owns a business. All business owners will exit their companies one day. They will not all do it voluntarily.
