Brace yourself. A lawyer is about to give you an unqualified, unequivocal statement.
Someday, you will die.
Hopefully that won’t be for a long, long time, but human mortality is inescapable. Since businesses consists of people, your business must address this issue or it too will perish. There are other, less morbid, ways that you or your partners will depart your business. Some will simply retire, while others may quit or be forced out in some fashion. Disability is always a risk.
It is for this reason that business advisers like me always stress the importance of a properly drafted buy-sell agreement. Hopefully, you have one (and have looked at it in the last three years). Too often, though, clients think that they are paying their lawyers to draft a document, when the real value is in the counseling to arrive at the contents of the document and comprehending the consequences of those decisions.
Do you really understand what happens when the buy-sell agreement is triggered? Let’s look at a couple of real-life examples.
A business owner dies suddenly and unexpectedly. Although he had a well-thought out estate plan, he was the business — a true leader in every sense. Now he is gone. His shares have flowed to his estate, but who is running the company? Is there a successor in the wings? Can the employees keep things afloat until management is stabilized? What about the surviving spouse and family; is there enough liquidity from the shares to support their lives without unduly burdening the business?
If you have the wrong answers to these central questions, the only option may be to sell the company. Even if that business is financially healthy, you have a distressed sale on your hands and those rarely achieve optimal valuations.
What about if one of your partners get divorced? Your buy-sell agreement likely treats this a sale and gives the remaining shareholders and/or the company the right to buy back the shares instead of splitting them between the spouses. The agreement may even provide valuation and payment terms that are not unduly burdensome. The good news is that the domestic relations court will likely honor the disposition of the shares. The bad news is that it will not simply accept your valuation, but instead will make its own independent (and litigated) finding of fair market value.
My wife (and new law partner) practices domestic relations exclusively and advises that valuation is a major battleground in divorces where private company equity is one of the largest assets in the marital estate. This creates risk for the business and its owners. Does the divorcing shareholder have enough to make up the difference? Can the business afford to bridge the gap? If not, then what? It is quite possible that a sale of the entire business may be the best alternative, especially if husband and wife are the primary shareholders.
So what is the solution? Regular readers of the Dealmaker Blog know that if there is one concept that all contributors stress (without collusion between us, honest), it is the importance of preparation and coordination between advisors. This area becomes vitally important when an owner departs the business. Failure to be prepared for these contingencies could force the company you labored to build to be sold under duress and not realize its optimal value. It requires a team effort to work through the legal, financial and operational consequences, such as:
- Dust off that buy-sell agreement and sit with your lawyer to go through the possibilities and make sure they coordinate with your estate plan.
- Get your accountant or other valuation expert to give you a sense of what the business is really worth today.
- Talk with your insurance and other financial advisors to make sure there are ways to fund a buyout under each of these scenarios.
- Finally, sit with your fellow shareholders and non-owner management and determine who is ready to step up or if you need outsiders to bridge the gap.
These are not the most pleasant things to think about and, unfortunately, there are not always easy answers. Confronting the issues while they are still hypothetical is definitely preferable to trying to solve them after the crisis is upon you. In doing so, you can avoid a forced sale of the business you have worked so hard to build and realize its full value through an orderly sale process at a more appropriate time.
Originally published in Crain's Cleveland Business