A lot of Buy Sell Agreements use a common valuation method called the “fixed price” method. It’s the easiest valuation method because the owners pick a number out of thin air and agree on a fixed value. The agreed on number determines the buy out price after a triggering event. Most Buy Sell […]
Recently a new client asked me to review his company’s Buy Sell Agreement because he and the other fifty percent owner of the company could not stand each other and were suing each other over the ownership of their four year old company that generated $20 million in gross revenue. One man did […]
Mercer Capital’s article discusses a very important topic – when is the best time to review your company’s Buy Sell Agreement?
“Almost every privately owned company with multiple shareholders has a buy-sell agreement (or other agreement that acts as a buy-sell agreement).
If your business is like most companies, then you have one too. You likely had an attorney draft the document for you several years ago. You and your fellow shareholders might have had some discussions about the specifics of the buy-sell language at the time, but these discussions were likely minimal. You then signed the document, put it in a file cabinet in the office and have not looked at it or thought much about it since.
True? Well, this might be an extreme example, but it highlights an important issue – most business owners do not have a current understanding of the details and potential pitfalls that lurk within their own buy-sell agreements. Most view these agreements as obligatory legal documents that can be forgotten about until needed. Unfortunately, when a buy-sell agreement is needed it is too late to fix any problems within the agreement.
For the past several years, Chris Mercer, the CEO of Mercer Capital, has used the image of a ticking time-bomb as a metaphor of what might be awaiting some business owners within their buy-sell agreements. Would you ignore an actual bomb that was ticking away in your file cabinet? Of course not, and you should not ignore your buy-sell agreement either.”
The article explains the Six Things That Should Be Clear in Any Valuation Process Agreement: […]
Estate of Claudia Cohen – Deceased Partner’s Failure to Update Buy Sell Agreement Cost Her Heirs $11 Million
The 2011 New Jersey appellate court case of Estate of Cohen v. Booth Computers is the perfect bad example that should scare the * out of every owner of a valuable business that is owned by multiple owners. I try and try to explain to my clients with valuable businesses how important a properly drafted and funded Buy Sell Agreement is to their loved ones, but more often than not people fail to address today the reality that they will die in the future.
When people go into business together or invest in valuable real estate together their most important document is a Buy Sell Agreement signed by all of the owners. This is true regardless of the type of business, i.e., a corporation, a limited liability company, or a limited partnership. For more read my article called “A Multi-Member LLC’s Most Important Document.”
The Estate of Cohen is the best example to illustrate the following Buy Sell Agreement facts of life:
- The owners of the business must read and understand the language in their Buy Sell Agreement. Words have meanings and economic consequences. Parties to a Buy Sell Agreement should go over the agreement line by line and word by word with the attorney for the company and their attorney and make sure they understand how the Buy Sell Agreement will work after a triggering event.
- The most important provision is the language that defines how the value of an interest to be bought and sold will be determined. A great amount of thought and effort must go into the valuation definition language.
- Regardless of the language in the Buy Sell Agreement, the owners of the company must, absolutely must, review the agreement not less than every two years (annually would be better) and revise it if necessary.
Had Claudia Cohen known of and followed the above advice her heirs probably would have been $11 million richer. Unfortunately for Ms.Cohen’s heirs, her Buy Sell Agreement is what nationally know business appraiser Christopher Mercer calls a “ticking time bomb.” Is your company’s Buy Sell Agreement a ticking time bomb? If you don’t know the answer to that question you probably need to take action and get an answer. […]
ESTATE OF CLAUDIA L. COHEN, by its EXECUTOR RONALD O. PERELMAN, Plaintiff–Appellant,
BOOTH COMPUTERS and JAMES S. COHEN, Defendants–Respondents.
DOCKET NO. A–0319–09T2
July 13, 2011
On appeal from the Superior Court of New Jersey, Chancery Division, Bergen County, Docket No. C-135-08.
Michael R. Griffinger argued the cause for appellant (Gibbons P.C. and Greenbaum, Rowe, Smith & Davis, L.L.C., attorneys; Mr. Griffinger, Kevin McNulty, Lan Hoang and Paul A. Rowe, on the brief).
Benjamin Clarke argued the cause for respondents (DeCotiis, FitzPatrick & Cole, L.L.P., attorneys; Frank Huttle, III, of counsel; Mr. Clarke, Russell J. Passamano and Erik Corlett, on the brief).
The opinion of the court was delivered by CARCHMAN, P.J.A.D.
In this appeal, we address the question of whether, under the facts presented, a family partnership agreement that provides for a buyout based on net book value may be enforced where the disparity between book value and market value is significant. In deciding this issue, we consider the difference between book value and market value as well as addressing the issue of whether the disparity between the two renders the agreement unconscionable and unenforceable.
We conclude, as did the trial judge, that the formula utilized in calculating net book value was appropriate, the buyout agreement was enforceable, and the disparity between book value and market value does not render the agreement unconscionable.
Plaintiff Estate of Claudia 1 Cohen, by its executor, Ronald Perelman, appeals from a judgment awarding $178,000 for Claudia’s interest in defendant Booth Computers (Booth), a family partnership in which her brother, defendant James Cohen, was also a partner. Plaintiff argues that the trial judge erred in finding that, under the buyout provision of Booth’s partnership agreement, it was entitled to only the net book value of Claudia’s interest in the partnership, as reflected in Booth’s financial statement at the time of Claudia’s death, rather than the fair market value of that interest, which plaintiff claims was $11,526,162.
Judge Contillo, in the Law Division, concluded that the value set forth in the financial statement was the “net book value,” the language of the buyout clause was not ambiguous, and was supported by substantial credible evidence in the record. The award did not render the partnership agreement unconscionable because of the disparity between fair market value and book value; moreover, there was a similar buyout after the death of the other Booth partner ten years prior. […]
Why Multi-Member LLCs Must Adopt a Buy Sell Agreement
A Buy Sell Agreement is the Members’ Exit Strategy. Don’t Go Into Business With Unrelated Parties Without an Exit Strategy
Bottom Line & Number 1 Reason Multi-Member LLCs Need a Buy Sell Agreement: Members of a multi-member LLC who DO not sign a Buy Sell Agreement are stuck with each other FOREVER unless they can agree on how to split the LLC pie when they cannot agree on anything else.
Although Arizona LLC law does not require that members of an Arizona LLC enter into a Buy Sell Agreement, I recommend that the members of every multi-member Arizona LLC (other than a husband and wife owned company) sign a Buy Sell Agreement. The purpose of a Buy Sell Agreement is to create a mechanism for the orderly acquisition of the membership interest of a member of the LLC on the happening of a specified triggering event. Without a written agreement that contains an exit plan, the members of an Arizona LLC are stuck with each other in sickness and in health and even after death because Arizona LLC law does not provide for the mandatory acquisition of members’ interests in an AZ LLC.
I have formed 4,800+ Arizona LLCs. As a business lawyer who began practicing in Arizona in 1980, I have seen the unfortunate results of too many companies (corporations and LLCs) where over time the owners became at odds and desperately needed a “company divorce,” but were forced to “cohabitate” indefinitely together in the business because they never signed a Buy Sell Agreement that contained a mechanism for a mandatory buy-out of an owner.
An Actual KEYTLaw Client Bad Example […]
Exciting Developments in Buy-Sell Planning
This issue of the estate planning newsletter examines exciting new developments in business succession planning – specifically, the use of LLCs to own life insurance for buy-sell planning purposes. Such a structure obtains the advantages of cross-purchase and membership interest redemption buy-sell agreements without many of the disadvantages of either traditional structure. This development is significant to all small business owners.
For many business owners, the business itself is their primary source of income both during working years and in retirement. Thus, buy-sell planning is critical for not only death planning but also disability and retirement planning during lifetime.
Unfortunately, the two traditional types of buy-sell agreements, entity purchase and cross-purchase agreements, have significant limitations and disadvantages that often prevent business owners from adequately preparing for many business succession issues.
With a redemption arrangement, the entity owns the life insurance and agrees to redeem the interest of a deceased owner at that owner’s death. The owner in turn agrees that his or her estate will transfer the interest in the entity back to the entity for an agreed-upon price. […]
Buy-sell agreements are some of the least understood, yet most important corporate documents in your client’s corporate files. Nearly every business of any size with more than one shareholder has – or should have – a buy-sell agreement. These agreements establish the mechanism for the purchase (and corresponding sale) of equity interests upon the occurrence of certain “trigger events.” Trigger events can be remembered by an acronym, QFRDD:
If you think about it, these events are called “trigger events” because someone almost certainly has a gun to his or her head, whether your company or a shareholder when they happen.
Buy-sell agreements come in three types: cross-purchase agreements, entity-purchase agreements, and hybrid agreements. Cross-purchase agreements call for individual shareholders to carry life insurance on the lives of other shareholders. This may not be economical (if a company has substantial economic value) or workable (if there are many shareholders).
Entity-purchase agreements call for a company to purchase shares when a shareholder leaves as result of any of the trigger events.
Hybrid agreements provide for the company to pass purchase rights to shareholders under certain circumstances. Most buy-sell agreements that we see in our practice are entity-purchase agreements.
There are really four ways an agreement can determine value when trigger events happen. […]
Buy-sell agreements are designed to accomplish one or more of the following objectives from one or more of several viewpoints: the corporation, the employee-shareholder, the non-employee shareholder, and any remaining shareholders. The buy-sell agreement provides for what happens to the shares of owners who leave, for whatever reason, whether favorable or unfavorable.
From the corporation’s viewpoint, the agreement may prevent the departing shareholder from retaining his shares. By requiring a departing shareholder to sell his or her shares to the corporation, the corporation and remaining shareholders eliminate any potential for conflict over future corporate policies with the departed shareholder. They also eliminate the potential for the departed shareholder to benefit from future success of the business created by the remaining shareholders. Finally, the agreements prevent a shareholder (or his or her estate) from selling shares to “undesirable” parties, enabling the remaining shareholders to decide who the next shareholder will be, if any. These reasons for buy-sell provisions apply to virtually all trigger events.
We use “QFRDD” to denote common trigger events for buy-sell agreements. […]
This short article is a warning against the blind use of legal forms, or templates, for developing buy-sell agreements. Parties to each and every buy-sell agreement need to take time to agree on the key business and valuation aspects of their agreements, then have a qualified attorney (who can also be involved in reaching agreement) draw up the document. What could be simpler? All the parties have to do is to agree on the events that “trigger” the buy-sell agreement, on who buys stock, and on the pricing and terms of the purchase. Also, it is helpful if the funding for the transaction is specified, as well. The problem is, if my experience is any indication, these things are almost never agreed to at the level at which it is necessary for the shareholders to understand what will happen when their buy-sell agreements are triggered by the quitting, firing, retiring, death, disability, divorce, etc. of a shareholder.
Many buy-sell agreements are funded, in whole or in part, by life insurance on the lives of individual shareholders, who may be key managers, as well. Life insurance is a tidy solution for funding when it is available and affordable. It is important, however, to think through the implications of life insurance from a valuation perspective whether you are a business advisor, business owner, or a valuation expert. The proceeds of a life insurance policy owned by a company naturally flow to the company.
Check out Chris Mercer’s blog post on four types of Buy Sell Agreement problems.
Mercer Capital: “The Single Appraiser, Select Now and Value Now buy-sell agreement valuation process is the one I recommend for most successful closely held and family businesses. I prefer this single appraiser process as the best available alternative for fixed-price, formula, and multiple appraiser agreements.
I recommend Chris Mercer’s excellent article on Buy Sell Agreements in the June 2011 edition of the CPA Journal.
Mercer Capital: “Promissory notes are used frequently as a funding mechanism when buy-sell agreements are triggered. However, most buy-sell agreements reflect very little thought or negotiation regarding the promissory notes that they contain. . . . Promissory notes issued pursuant to the operation of buy-sell agreements are fairly common and often do not […]