Many small business owners start their operations with family members without a keen eye for potential dilemmas in their future business relationship. Consider Michael as an example; local chef who wishes to open up a gastropub in the community with his sister, a businesswoman, with significant management experience.
Michael’s business plan is simple enough: he will run day-to-day operations, prepare the food and train additional cooks, while his sister provides funding and assists with HR and administrative work for the restaurant. Though in the back of his mind Michael contemplated some drawbacks of going into business with his sister – day-to-day arguments over operations or confusion of overlapping tasks – but Michael never thought about the possibility of going into business with his sister’s new family.
In fact, one-year into the co-venture Michael’s sister tragically died. This left everything to her husband, a well-intentioned albeit inexperienced businessman, whose priorities misaligned with Michael’s goals for the restaurant. For Michael, the business is now stuck in limbo with him having to take his brother-in-law’s ideas as though they were his sister’s.
Though the above scenario is overly simplistic, it serves as a legitimate example for why many closely held companies require structurally sound Buy/Sell Agreements. These legal agreements may be found as single provision(s) in Shareholder Agreements, or even stand alone as their own contract. Their purpose is inherently the same; plan and prepare for the death, disability, incapacitation, or any other named event occurring to an owner so that other interested owners have predetermined options as to the fate of the company.
In the above example, Michael could have engaged an attorney to draft a Buy/Sell Agreement to look something like this: “upon the withdrawal, death, or mental disability of any shareholder, the other shareholder(s) shall be required to purchase his/her interests at a formulated price based on the valuation of an appraisal expert unanimously chosen by the owners.” Simply put, Michael could have retained all of his sister’s interests in the company and avoid decision-making with her immediate family.
Of course, not all Buy/Sell Agreements are created equal nor do they typically contemplate all of the owners’ interest in one sentence. Buy/Sell provisions are not limited to interfamilial owners, they can determine which events will trigger a sale, who the owners may sell to, the specific price or formula dictating such sale, a particular way to valuate the business and its interests, state any competitive restrictions, dictate logistics for payment of interests, and the list goes on.
Often times in the specific instance of death companies will also serve as beneficiaries under a life insurance policy covering the lives of its owners. After all, the likelihood of Michael securing payment for his sister’s ownership interest out-of-pocket is dependent on the company’s success as well as Michael’s personal financial status.
Under a company’s life insurance policy taken out on Michael’s sister, the proceeds of the policy would be distributed first to the company, and then to her family as compensation for her ownership interests. For many grieving family members, there is upside to the complete liquidation of company interests without the need to get caught in the weeds of corporate management.
The overall objective for closely held businesses in such situations is a focus on simple preparation.
If Michael knew about the possibility of his brother-in-law taking a majority stake in the restaurant business, he very well could have engaged an attorney to look over the governing corporate documents alongside his sister.
Whether you are interested in starting a closely held business with one or more partners or have been operating a business for several years, asking an experienced attorney about the applicability of a Buy/Sell Agreement is worth the time and money you may save to help sustain your business and protect your hard work and personal investment.