Keeping It In The Family – Buy-Sell Agreements

There are at least three key issues that arise during the succession of a family business: succession of ownership, succession of leadership and succession of management.

Disputes and misunderstandings surrounding these issues are often resolved by properly drafted and executed Buy-Sell Agreements (and by Family Business Prenuptial Agreements).

As many of you have heard MANY times: “Fair is not always equal, and equal is not always fair.”

Gifts or sales of stock to family members should be accompanied by buy-sell agreements –agreements that restrict the family member from transferring ownership outside the family. Prior to the time of the gift or sale, parents should discuss their family business plans for stock ownership, and how important it is for the stock of the family business to remain within the family. (Although we discuss “Stock”, buy-sell agreements are also used for membership interests in LLCs and partnership interests in partnerships.)

Additionally, many “founders” of family businesses “encourage” the next-gens to execute premarital agreements prior to marriage in order to make sure the family business stays within the family. A properly executed “family business premarital agreement” can protect the family business by keeping the family business as “separate property.” The concepts are similar for buy sell agreements, and

this is the time many people are considering year-end gifts of family-business stock. Buy sell agreements provide the family business owners the flexibility of giving stock at an early age without the fear that the stock could ultimately end up in the hands other than “blood.”

Situations often covered in Family Business Buy-Sell Agreements include answers to the following questions:

What happens upon the death of a shareholder (member)?

 

Valuation

Life Insurance?

Timing

What happens upon the total disability of a shareholder (member)?

 

Valuation

Timing

 

What happens if a shareholder (member) gets a divorce?

 

Valuation

Timing

 

What happens if a shareholder (member) has a bankruptcy?

 

Valuation

Timing

 

What happens if a shareholder (member) competes?

 

Valuation

Timing

 

What happens if a shareholder (member) leaves the company with no notice?

 

Valuation

Timing

 

 

 

What happens if a shareholder (member) leaves the company with “proper” notice?

 

Vaulation

Timing

 

 

What happens if a shareholder (member) is fired for “cause?”

 

Vaulation

Timing

 

Even if all parties agree on the fair market value of the company, an appraisal is recommended so that the family business has a third party valuing the company. This helps with the IRS!!!!

a. Critical Valuation issues that need to be addressed in every Buy-Sell Agreement (As discussed by Tim McDaniels, Rea & Associates)

 

i. Control value verses minority value

 

ii. Fair Market Value verses Investment Value

 

iii. As of Date

 

iv. How to choose an Appraiser

 

v. Does the appraised value include insurance proceeds?

 

 

b. Valuation Options in Buy-Sell Agreements

 

i. Fixed Price

 

 

ii. Formulas

 

 

iii. Push/Pull (Shotgun) Agreement

 

 

iv. Right of First Refusal

 

 

v. Valuation Process Agreements

 

1. Single Appraisal Process Agreement

 

2. Multiple Appraisal Agreement

 

 

vi. Proactive setting valuation annually based on Snapshot Valuation