FIVE FATAL ERRORS COMMITTED BY BUSINESSES
PART V—NO BUY-SELL AGREEMENT

By Albert G. Marquis, Esq.

This is the final installment of a five part series dealing with fatal errors committed by businesses: deficient employment manuals; inadequate corporate records; incomplete contracts; inadequate insurance and no buy-sell agreement. Today we are discussing the problems associated with partners and/or shareholders operating a business without a buy-sell agreement.

First, let’s define the subject matter. The primary purpose of a buy-sell agreement is to provide for a purchase price (and other terms) of an agreement whereby a deceased shareholder’s (or partner’s) share of a business can be purchased after they die. Other benefits of such an agreement include: providing for a buy-out price in the event a shareholder voluntarily or involuntarily leaves the company; establishing a buy out price in the event of a shareholder’s disability; and establishing a value for the company in the event one of the shareholders goes through a divorce.

A simple example will demonstrate why it is foolhardy for two or more partners to conduct a business without a buy-sell agreement. Suppose Jeff, Scott and Al decide to start up a construction company together. They have been together for five years, and they are beginning to make some serious money. Suddenly Al drops dead from a heart attack.

Now suppose Al’s wife, Gertrude, doesn’t want anything to do with the business operations. Or suppose that she wants to be involved in the day-to-day business activities, but Jeff and Scott don’t want her around. In any event, she wants to sell Al’s stock in the company, and Jeff and Scott want to buy that stock. So far so good, except that Jeff and Scott think that $100,000 is a fair price, whereas Gertrude is convinced that her share of the stock is worth at least $1 million. Soon both sides will have lawyers, a lawsuit will be filed, the books and records of the company will be copied and recopied and scrutinized and detailed, and who knows what the results will be?

Similar problems arise when one of the shareholders gets divorced. If the partners (including spouses) have not previously agreed upon a value for the company’s stock, then the company’s books and records are subject to subpoena while husband and wife battle over the evaluation.

Alternatively, one of the partners could leave and set up a competing company. Obviously the remaining partners do not want him to retain his stock, but how does anyone decide upon a fair price?

All of these problems are resolved with a buy-sell agreement. Because everyone is in the same boat—not knowing whether they will eventually be a buyer or a seller—it is fairly easy to negotiate a fair and reasonable price. Later, when a shareholder gets divorced, leaves the company or dies, there is a strong likelihood that the company’s books and records will not be subpoenaed. Just as importantly, a shareholder knows that if he dies, his family will not inherit a lawsuit. Instead, his family will receive a reasonable cash payment for the stock that he owned in the company.

Moreover, the funding for this cash payment can come from a life insurance policy purchased by the company. Relatively inexpensive term insurance can be purchased, and the premium payments are made with before tax dollars. The company should be named as the beneficiary so that, when a shareholder dies, the insurance proceeds will come to the company, which can in turn pay out whatever portion is necessary to buy the stock. Therefore, the company need not come out-of-pocket with any funds (and in fact might come out ahead if there are excess insurance proceeds).

Every company with multiple partners or shareholders should have a buy-sell agreement. Furthermore, if it would be burdensome on the company to come up with enough cash to purchase the stock of a deceased shareholder, then key man insurance should be purchased as well. The company, the remaining shareholders and the deceased shareholder’s family all benefit from this arrangement, and there is no downside. Therefore, if you have partners, take the time now to negotiate and set up a comprehensive buy-sell agreement.

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Albert G. Marquis is a partner with the Las Vegas law firm of Marquis & Aurbach. He can be reached at (702) 382-0711 or visit the firm’s web site at www marquisaurbach.com