In a recent conversation with an author, lawyer and business transition planner, the topic of buy-sell agreements for companies that are 100% owned by a single shareholder came up. Nick Niemann, author of The Next Move for Business Owners, was talking about transition and exit planning when the broad topic of buy-sell agreements arose. I’m not sure who mentioned the subject first, but we both agreed that it is a very good idea for a company to have a buy-sell agreement with its shareholder, even if there is only a single owner.
We did a bit of research and found that there are agreements called “one-way” or “unilateral” buy-sell agreements. These agreements provide for an owner to contract with a third-party, perhaps a key employee or another capable buyer, to purchase a business on the death of an owner with life insurance proceeds. The purchaser(s) could also be adult children of the deceased owner. Such agreements are designed to provide liquidity for the family/heirs of a business owner. And they may provide for the orderly transfer of the business to the children. Read here, or here. Such agreements can be helpful, but they may leave the children/heirs with ongoing problems with their new investments.
I hope this post contributes some new ideas for business owners considering one-way buy-sell agreements or for those without a buy-sell agreement at all. Nick Niemann and I were talking about buy-sell agreements that, whether they are funded with life insurance or not, provide, for all new shareholders to become parties to the buy-sell agreement following the death of the 100% owner. We have both seen circumstances where stock was transferred to children in the absence of a buy-sell agreement. That is not a propitious time to begin thinking about an agreement for the now multiple owners of a business. Further, unless the one-way agreement provides for an ongoing pricing mechanism and provides for the future existence and needs of additional shareholders, the new owners may be in the same “one-way” boat without an effective buy-sell agreement on a going forward basis.
The following thoughts therefore relate to three circumstances involving buy-sell agreements for 100% owners of businesses.
- If a one-way agreement is contemplated, it should consider the ideas for continuity discussed below.
- If a one-way agreement is in place, it should be reviewed to address the same continuity concepts.
- If no buy-sell agreement is in place, it is time to consider a buy-sell agreement even for 100%-owned businesses.
The following discussion should shed some light on this topic.
Why a Buy-Sell Agreement for a Single Owner?
Why should there be a buy-sell agreement when there is only a single owner? What happens in the event of the death of a single owner?
- Chances are, the stock will be transferred by will to one or more children, or to a trust or trusts for the benefit of the owner’s children and/or other beneficiaries.
- Assume there are three beneficiaries and they are siblings. The stock passes to each in one-third equal amounts. If there is no buy-sell agreement, the kids (likely grown) would each own shares that are not subject to any buy-sell agreement. Anyone familiar with similar situations know that agreeing on a buy-sell agreement is the last thing on anyone’s mind following the death of a parent.
- Who will be in control of the business upon Dad’s passing? Any two of the three siblings could, presumably, vote together and control the business. But that “agreement” could be shaky, and there is room for shifting loyalties. Assuring a rational continuity of control of the business is one good reason for a buy-sell agreement before the death of a single owner.
- What restrictions are there on the disposal of shares to outsiders for any of the siblings? In the absence of a buy-sell agreement, there would be none.
- What if one sibling desires to sell his or her shares to siblings. What is the price and how will it be determined? What are the terms? At what “level of value” will the transaction be priced? What rights for other disposition does the sibling have? In the absence of a buy-sell agreement, he or she might be able to dispose of the shares to a party that would be undesirable to the remaining siblings.
- In the absence of a buy-sell agreement for the 100% owned company, what arrangements are in place to “hold the family together” in the event of untimely death? In the absence of a buy-sell agreement, likely none.
What Terms Should Be Considered for Single-Owner Buy-Sell Agreements?
What would a buy-sell agreement for a single-owner business look like and what factors would it consider? The main issues relate to what might happen in the event of the untimely death of the owner. Consider that a buy-sell agreement might have at least the following terms or conditions:
- Subsequent owners are subject to the buy-sell agreement. A single-owner buy-sell agreement might require that any subsequent owners of all or a portion of the shares agree to be subject to the agreement. In the event of the death of the owner, the three siblings in the example above would each be required to sign on as subject to the agreement. If the shares are initially transferred to a trust or trusts, it could be a requirement that any distributions from the trust require the new owners to be subject to the agreement. This is a legal issue and obviously would require the guidance of an attorney with experience in such matters. This seems highly preferable to having the three siblings start working on a buy-sell agreement from scratch.
- Basis for pricing for the agreement. The single owner might not be concerned about pricing for himself; however, he should be concerned about future pricing for his children. In my view, the best pricing for future transactions would be based on a single appraiser who provides annual or every-other-year appraisals of fair market value for the buy-sell agreement. In this case, the owner would have some control over who would do the appraisal. He could, in fact, have the appraisal done each year so that the price and pricing mechanism are visible for the children while he is still alive.
- Level of value for the agreement. Most agreements will call for appraisal at the financial control level of value. If this is specified, it should be clear. If appraisals are obtained annually, everyone will know what this means.
- Restrictions on ability to transfer shares to outsiders. Most buy-sell agreements provide limitations on the ability of owners to transfer shares to new owners outside the group.
- Terms of any transaction under the buy-sell agreement. The owner who develops a buy-sell agreement prior to his death has the opportunity to stipulate the terms under which future transactions might occur.
- Trigger events other than death. The single-owner of a business has the ability to write into the agreement the identification of trigger events other than death. These could include, in the event that a sibling works for the business, the quitting or firing of an owner, retirements, disabilities, and other possible trigger events.
- Other legal issues. Competent counsel is required to develop workable buy-sell agreements. Counsel will suggest other terms that are appropriate for the agreement.
Who Should Be Concerned About Buy-Sell Agreements for Single-Owner Businesses?
Who should be concerned about a 100% owner having a buy-sell agreement?
- The owner. The owner who passes his stock to family does not do a complete job, it seems to me, if he does not put a buy-sell agreement in place prior to his death that will govern, at least initially, the future ownership of the stock.
- The children (or heirs) of the owner. The children should desire some certainty about their future ownership rather than the cloud of ownership where future agreements regarding a buy-sell agreement must begin from scratch. It is difficult under the best of circumstances for related or unrelated parties to spend the time and concentrated effort necessary to create a buy-sell agreement. Having an agreement in place upon Dad’s death is a good place to start.
- Advisers to the owner. Advisers would be doing their client owners a service to suggest (and strongly) that they implement a reasonable buy-sell agreement.
What if a business owner says that he really doesn’t need a buy-sell agreement because he owns all of the stock? Ask him (or her) to read all of this short post. If you have any ideas for additional consideration or discussion, please comment below. Thanks!
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!