Sell Agreement Structure – Oh, no you didn’t!

Ron Burgundy: “That is without a doubt the dumbest thing I’ve ever heard.” From Anchorman 2

When I deal with a new privately held client, I always ask if there is a “buy/sell” agreement amongst shareholders.  I get the usual range of answers from “a what?” to “sure – the lawyers made us do one.”  I can’t emphasize the importance of having one especially in the case of death or disability.  The insurance brokers out there will usually press this issue since funding this potential eventuality with insurance is one of many solutions – but please work through that and get to the need for an agreement.

I have blogged before about not getting into a deal without knowing how you get out and the related issue of providing liquidity for shareholders if for any reason one leaves.  My advice has always been to address all the shareholder issues early in the corporation’s life when everyone still likes each other and is talking. I don’t want to dwell again on shareholder liquidity here, but I just ran across a case that reminded me in a very stark manner what not to do when setting up a buy sell.  Let me explain.

Four family members had a very successful business which they sold.  Each became, what you might call, independently wealthy.  All were involved as owners in starting another business which is now doing very well.  I was brought in to review some equity/shareholder/key employee issues.  In the course of completing my work, I asked my standard question regarding a buy/sell agreement.  The reply was one of the standards: “Yep, and it is funded by insurance, so no problem.”  As you know, I am still, at times, an auditor at heart so I asked to see the agreement.  I read it and my only comment (from my Italian heritage) was “madonne.”  It was structured such that surviving family members were personally fully liable for buying out the shares of a departed or disabled shareholder to the extent the buyback was not covered by insurance.  A quick calculation showed that, net of life insurance in place (and there was no disability insurance) this could mean a multi-million dollar non- recourse personal liability for 10 years.

I approached the shareholders and asked them to confirm, with legal counsel, my layman’s interpretation.  The lawyer (who had not prepared this agreement) used the above quote from Ron Burgundy – with a few deleted expletives.  Once the shareholders found out… the “you know what” hit the fan.  It was Apocalypse Now live!  Every possible emotion came out – anger, frustration, disbelief, etc.  There were no happy campers.  Fortunately, working with other advisors, we were able to structure an alternative that mitigated most of the risk. But this was a time bomb just waiting to go off.

So, my message is simple, boys and girls.  Please make a periodic review of all shareholder agreements part of a normal annual review process – perhaps tied to your review of corporate tax returns or insurance coverage.  You don’t need someone using this quote to describe your situation.

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