Buy / Sell Agreements – Don’t Let This Happen to You
“Doug died” – two word obituary of Doug Legler of North Dakota
My sister and I share Doug’s irreverent view of death. I am sure this may give some of you cause for concern but perhaps we both realize there is little you can do about death so why not poke fun at it. Quite honestly, besides the strange looks we get from other family members, what’s wrong with it? When Steve Lawrence the singer passed, our natural response was “blame it on the ‘Bossa Nova’” his late wife’s hit song; the death of Jim Henson (Muppet creator) prompted an inappropriate reference to Kermit the Frog’s tune – it’s not easy being blue.
But in business, death of an entrepreneur is a serious issue – how do you buy out an owner who has passed. Though the event is inevitable, suppose you don’t have the risk covered? Good planning and the right insurance can mitigate this risk but sometimes “stuff happens” and you end up in a bind. I see this quite often when I inquire about buy / sell agreements and I thought I would share one classic example with you.
This may take a couple of minutes to set the scene, but please bear with me. I had a company I consulted with and after addressing a series of ownership issues, I asked to see the buy/sell. This is standard operating procedure for me and while I am not an attorney, I assume that if I have concerns or issues based upon what I read my entrepreneur / client probably does as well. While this agreement was pretty straight forward, I found what I thought was a rather toxic provision; at death the surviving owners bought out the stake of the deceased owner personally utilizing a full recourse note for any shortfall in purchase price which life insurance did not cover. This business was very profitable and the owners all had significant wealth. What this meant in laymen’s terms was that the survivors were “fully on the hook” for the note to cover any insurance shortfall. When an attorney reviewed the agreement, he agreed with my assessment.
I did a quick calculation and realized that based on current earnings, each of the survivors would need to use all of their accumulated wealth to pay for the current shortfall with the only out being a potential “fire sale” of the business to generate liquidity. Fortunately, we caught the problem, changed some of the toxic terms and obtained additional insurance to close the “gap” and just in time as certain key owners became uninsurable just a year or so later.
While buy / sells cover a shareholder’s departure under various scenarios, many situations can be negotiated with living principals thus not necessarily forcing liquidation as would be the potential outcome here. So my simple advice is this – – just as a periodic review of your will and succession plan is a best practice, your buy / sell agreement should be part of that process. You don’t want an obituary (whether two words or two pages) to result in turmoil for your business.
