My first book on buy-sell agreements was published more than a decade ago. I was writing the book in installments on my then-blog, www.MerceronValue. A long-time friend, William [not his real name], an experienced business appraiser, called me to relay a true story about how one buy-sell agreement went really bad for his family.
“In the early 1960s, Dad was friends with three men who worked in the [wholesale distribution] business. They kept talking about how they could do things better than their respective companies were doing, and finally believed themselves.”
So, I asked, “What did they do?”
William went on, “Mom and Dad had saved about $250 thousand by that time, and the other three guys were able to scrape together a similar amount, so they went into business with a total investment of a million dollars.”
So I asked the logical question, “How did their company do? Were they able to do things better than the folks they had worked for?”
“Things went surprisingly well for quite a few years,” said William. Dad was able to put my brother and me through college comfortably, and he and Mom were doing well.”
Since William had called me because I was writing about buy-sell agreements, I knew there had to be a connection, so I asked, “Did they put a buy-sell agreement in place?”
“Yes, they did,” replied William, “but not a very good one.”
“What do you mean?, I asked.
“Well, they the pricing mechanism was a fixed price, and they set the price at $1.0 million, or the sum of their collective investments at the time they started out.”
My next question was, “Did they ever update the price?” At this point, I was fearful of the direction William’s story would take.
William went on, “They said they would update the price every year. The buy-sell agreement even called for annual price re-setting on the part of the shareholders. But they didn’t do it.”
I could tell that the story was not going to end well. “So what happened?” I asked.
“The ending of this story is not a happy one,” said William. “By the time they had been in business for about a dozen years, the company was doing very well. I estimate conservatively that the business was worth about $5 million. Sales and earnings had grown every year, and the company was paying a handsome distribution to each of the shareholders.”
“What’s not happy about that?” I asked.
“Well, Dad had a massive heart attack and died quite unexpectedly. There had been no warnings.”
“What happen, then?”
“The other shareholders pulled out the buy-sell agreement, which still said that the price for trigger events was based on a $1 million valuation, and they stuck to it.” William clearly had more to say.
“Tell your readers that buy-sell agreements are critical documents and they need careful attention on the part of owners. My Mom received just $250 thousand for my Dad’s stock, rather than my conservative estimate of $1.25 million of value.”
“Wow!” I said.
“Wow! Is right,” was William’s response. “The difference between receiving $250 thousand, rather than $1.25 million for my Dad’s stock made a critical difference in my Mom’s ability to live independently for the rest of her life. Even worse, she was bitter at Dad’s former friends and shareholders, and never got over that bitterness for the rest of her life.”
I told William that I would retell his story, with the names and circumstances changed for confidentiality reasons, to help other business owners focus on their buy-sell agreements. And so, I continue to retell the story…
Moral of the Story
If your company has a fixed price buy-sell agreement, it is critical that the shareholders agree on its revaluation each year or so, at the minimum. William’s Dad basically bet that one of the other owners would be the first to die, and he lost the bet. Unfortunately, that bet had a long-term and devastating impact on his wife and family.
We will address the solution to this buy-sell agreement problem in a subsequent post.
Until then, be well,
Valuation is important for business owners for many reasons. One of these reasons is for the operation of buy-sell agreements. If you are thinking about your buy-sell agreement (and you should be), then take a look at Buy-Sell Agreements for Baby Boomer Business Owners, my Kindle book on the topic.
I’ve priced it at $2.99 so you won’t have to think about the expense. So click on the image of the book. You will be taken to Amazon. Then buy the book. Don’t be mislead by the price. It is a full length book. If you like it, as most readers have, please take a few minutes and review the book on Amazon!
Additionally, my two most recent books are available in an Ownership Transition Bundle. The bundle, priced at $35 plus s/h, has been attractive for many business owners, appraisers, and attorneys.