More members than you think may be wondering what to do next with the businesses they’ve worked so hard to build. Here are three basic types of buy-sell agreements and 21 key issues to consider.
While most associations devote enormous time and resources into recruiting and retaining up-and-coming members of their profession, don’t overlook your longest standing members. While many of them are in the final stages of their careers, mature members can be highly influential when it comes to recommending your association to others—making key introductions to industry suppliers, potential speakers, government organizations and academic institutions. Whatever you do, you don’t want to ignore them.
Sure, some mature members continue to serve as volunteers or board members as they wind down their careers, but have you thought lately about the membership benefits—real benefits—that are targeted just for them?
In my decades of involvement with trade associations and other not-for-profit organizations, I’ve found that many long-standing members are owners of companies or firms that serve their industries. What’s more, they’re often the founder of that company or firm, which is often family-owned.
You might be surprised to learn that many of these companies or firms—no matter how large and successful—do not have real succession plans in place. Many times the founder does not have a child, spouse or trusted employee with the willingness (or chops) to take over day-to-day management of the business.
And, boy it gets dicey when emotions and family dynamics get mixed in with balance sheets and income statements.
Helping members protect what they’ve worked so hard to build
Almost all owners of closely held businesses put all of their time, effort and money into launching and growing their businesses. Tragically, they put little effort into protecting what they have built from devastation caused by one or more of the owners leaving the business. Without an appropriate “exit” plan in place, changes in business ownership can be worse than a Hollywood divorce—bitter, expensive and devastating to all involved. And worst of all, a very successful business, which contributes greatly to the community and which provides lots of jobs, may get sold for way below fair market value, and it often merges or relocates.
Don’t be fooled! Changes in ownership happen every day in all types of businesses for a multitude of reasons: death, retirement, disability, divorce, voluntary and involuntary termination of employment, lawsuits, financial and economic setbacks, bankruptcy, and selling and gifting interests, just to name a few. The disruptions caused by these events usually result in severe financial consequences for everyone involved, including collateral damage to customer, supplier, banking and employee relationships, as well as to long-term company goodwill.
Real world example
A highly successful engineering firm that I represented got into a major shareholder dispute. There were three owners, each with a Type A personality and ego to match. There was no written agreement between the owners. The firm lost valued employees who were not confident about how the owner disputes might be resolved. Several major customers took their business elsewhere because they were concerned about the firm’s ownership, management and the ability to follow through on commitments. The disruptions also made it difficult to get much needed business financing.
Fortunately, I was able to help steer the firm through most of the problems, which was fortunate because it had been a very successful business. However, a well-drafted agreement would have provided a framework to settle most of the disagreements with a lot less disruption, time, expense and related business losses.
Consider a buy-sell agreement from Day One
Perhaps the biggest tragedy is that most, if not all, of the aforementioned problems can be avoided by putting a well-drafted buy-sell agreement in place right from the start. That’s when all the owners are still in the “honeymoon” stage of the business and relations are most amicable. However, it is never too late to put a buy-sell agreement in place, and some honest thought and open communication will strengthen and protect the business and bring peace of mind to everyone involved. Remember, ownership changes are bound to happen, but having a plan in place to deal with those changes will always smooth out the road ahead.
Now that we’ve helped members understand the importance of a buy-sell, where do members go from here? First, they should consult with an experienced business lawyer who can walk them through the process and help craft a plan that fits the specific needs of both the business and the individual owners. Second, they should understand that no two agreements are ever the same, although they generally fall into one of three categories:
- Cross-Purchase Agreements, which can be ideal for a business with a small number of owners. When a triggering event occurs, the remaining owners directly purchase the departing owner’s interests in the business.
- Stock Redemption Agreements, which can be simpler and easier to structure. Generally, they can be better-suited for entities with more owners. With these types of agreements, the entity purchases the ownership interests of the departing owner. The remaining owners receive an increase in the value of their interests, not in the number of interests they own.
- Hybrid Agreements, which are a combination of cross-purchase agreements and redemption agreements. Generally the entity has the obligation to redeem the interest of the departing owner, but the remaining owners have the option of directly purchasing the departing owner’s interests if the entity is unwilling or unable to do so.
In order to determine which type of agreement will best suit your clients’ needs, consider the following issues:
- How many owners does the business have today and will have in the future?
- Is the business family-owned or are third parties involved?
- What type of business is involved, and are there specific issues that need to be addressed relating to the entity’s business, such as professional licensing or trade issues?
- What is the legal structure of the business: corporation, S corporation, partnership, limited liability company?
- What is the age and health status of each business owner?
- Is each of the owners insurable?
- What percentage of the business does each owner hold?
- What is the value of the business, and how is that value determined?
- What are the tax implications of each type of agreement?
- What are the transfer implications of each type of agreement?
- What restrictions will be put on the transfer of interests?
- Will the interests be subject to rights of first refusal?
- How will the business be valued and the purchase price determined? How often will the business be revalued? Will the interests be valued differently depending on the specific transfer event?
- Will there be penalty provisions for violating the terms of the agreements and/or conduct damaging the business?
- How will the transfer of interests be funded? Will insurance such as life insurance and disability insurance be mandated, and if so, how will premiums be paid?
- How will the transfers be paid—all upfront or over time? If the payments are over time, what are the terms and the arrangements to secure payment?
- Is the agreement aligned with other important legal documents, such as the entity organizational documents, employment agreements, business agreements and contracts, banking agreements, and the estate planning documents of the individual owners?
- Coordinate the agreement with related property that may be owned by each of the business owners. Examples include affiliated businesses, insurance policies, land and personal property, intellectual property, and leases.
- How will termination of the business be handled?
- How often will the agreement be reviewed? Doing so annually is a good idea.
- How will disputes related to the agreement be handled—litigation, mediation or arbitration?
The foregoing is not a complete checklist of every issue that needs to be considered, but it will give your members a good platform to begin discussions between the business owners and their legal counsel.
Properly structured buy-sell agreements are critical to the survival of any closely held business; they are not an option. Also, these agreements must be tailored to the specific needs of the business. One size doesn’t fit all. What’s more, businesses and relationships constantly change; consequently, buy-sell agreements must be reviewed and updated regularly. An out-of-date agreement is next to worthless. Finally, by reminding longstanding members to implement (and regularly update) their business succession plans, will continue to reinforce your membership value proposition.
Your longest standing members can be just as apprehensive and confused about the future as your youngest members. Providing them with valuable insights and resources about the next stage of their working life can create tremendous goodwill for your organization and have a significant positive multiplier effect on your future membership base.
Robert G. Alexander, JD, LLM, is the president of the National Association of Estate Planners & Councils (NAEPC) and is on the board of directors of the Estate Planning Law Specialist Board. He is the president of Alexander Law Offices SC in Milwaukee, Wisc., where he concentrates his practice on wealth transfer, asset protection and family business planning.