More than a decade ago, I was writing my first book on buy-sell agreements (the fourth is in process now). I wrote it in installments to keep momentum. While I was working on that book, a long-time friend, let’s call him William, who had significant knowledge about the value of businesses, called me to relay a true story about how one buy-sell agreement ended very badly for his family.
The Story Starts Well
“In the early 1960s, my father was friends with three men who worked in a segment of 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?”
A Fixed Price Buy-Sell Agreement
“Yes, they did,” replied William, “but not a very good one.”
“What do you mean?” I asked.
“Well, 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.
Rest of the Story
“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 happened then?” I asked.
“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! 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.”
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
Betting is for the horses or the casino. Betting is not for the investment your clients have in their businesses. Every time a fixed price agreement goes into effect, all the shareholders are betting. Why? History and experience tell us that the story of William’s father, in which he bet, literally, the value of his ownership in a successful business, is not acceptable.
William’s dad bet, not intentionally, but bet nevertheless, that one of the other owners would be the first to die. Unfortunately, he lost the bet, and it mattered greatly to William’s mother.
Solution to the Problem
My first suggestion for advisers of businesses that have fixed price buy-sell agreements is that they recommend, strongly, that their clients eliminate their fixed price agreements and replace them with what I call a Single Appraiser, Select Now and Value Now pricing mechanism. In the alternative, I recommend that they amend their fixed price agreement to provide for a single appraiser pricing in the event that the fixed price in their agreements is more than a year or two old.
I’ll write more about this and other pricing mechanisms for buy-sell agreements in coming posts.
Until next time, 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 to many business owners, appraisers, and attorneys.