Operating a business with your brothers, sisters, and/or cousins is one of the most complex arrangements facing family businesses. Indeed, sibling or cousin family businesses can inherently last a long time. As such, just as good fences make good neighbors, good buy-sell agreements make good sibling/cousin family businesses. Think of it as a pre-nuptial agreement before getting into business together.
The purpose of the buy-sell agreement is to document the details of what will occur if one of the parties dies, becomes disabled, wants to get out of the business or is forced out of the business. The most common concern is the death of a partner.
If a partner dies, then without a buy-sell in place, the ownership would pass over to either the partner’s spouse or heirs. If you think your brother’s wife and kids are wonderful people, but you don’t want to be business partners with them make sure the ownership passes back to the corporation or to the remaining owners.
But because that ownership may have substantial value, the spouse or heirs should get their due. The best way to handle this is to have life insurance policies on each member of the buy-sell such that liquidity can be available for the heirs.
At the same time, if the partner’s contribution was equal to their share ownership, then the company will be affected by having lost a key employee, which means they will be difficult to replace. Having some additional liquidity to buffer this would also be advisable.
Another key scenario is when one or more partners is a minority shareholder because those shares are subject to a minority discount upon sale. Thus, it is very important to establish a valuation method for a buy-sell. James Duggan, an attorney who made a presentation at a buy-sell workshop I recently attended in Chicago, said there are really five ways to do this:
• Agree to a value, but adjust annually
• Agree to a formula to determine value
• Use a certified appraiser, or multiple and take an average
• Value equals insurance proceeds
• A combination of all of the above
However, from anyone’s perspective, it is critical to talk through all the ramifications of ending a business relationship before putting a buy-sell into place. Especially when there is more than one partner involved. With only two children per generation, there could be at least four members of the family business in the third generation. While there are templates available and “standard scenarios” exist, each business and business relationship can be different. Be sure you all sit down and have a constructive family business meeting. What you want to avoid most of all is having to execute a buy-sell and find out that it does not accurately convey what your original intentions were when it was put into place.
Henry Hutcheson is a nationally recognized family business speaker, author and consultant in Raleigh. He can be reached at Familybusinesscarolina.com.