Why Are Family Business Buy-Sell Agreements So Hard to Implement? PDF Print E-mail

By Wayne Rivers

A noteworthy attorney once lamented that people call his office and ask for “a simple buy-sell agreement.” His reply is always “there’s no such thing as a simple buy-sell agreement.” He’s right; crafting a good, solid, far reaching buy-sell agreement is one of the great challenges in family businesses. It’s astonishing that even today, knowing that the buy-sell is one of the most fundamental legal documents a family business can have, many still don’t have even the most basic type of agreement. And those that do exist tend to have holes big enough to drive a truck through in terms of the 25 must have components of a modern buy-sell.

Why are family business buy-sell agreements so hard to craft and implement? Let’s explore the reasons.

   
 

1. Fear of Conflict
Two siblings sat down and said, “Boy we really do need a buy-sell agreement,” and began to discuss some of the basics. Realizing that they were far apart on a host of issues, that old family bugaboo – the morbid fear of conflict – raised its head at the first mild difference of opinions, and they hastened away from the meeting table resolving never to go back there again. Even the merest discussion of various kinds of buy-sell provisions can reveal misalignment and misunderstandings. That’s not a valid reason for family businesses to avoid buy-sell planning. In fact, it’s probably a loud and clear signal that the family enterprise needs to undertake MORE long range planning and discussion in order to get potentially troublesome issues on the table and resolved.

   
   
       
        2. Legacy 
Senior generation family business owners struggle with what their legacies will be after they’re gone. They worry that buy-sell agreements, which some perceive as rigid, will take away their flexibility and creativity when it comes to inheritance time. Maybe some in the family might construe the buy-sell to be “unfair” in some of its provisions. Perhaps there could be a perception of favoritism towards one family member or another. In this manner of thinking, therefore, a buy-sell agreement isn’t a document to be prized and valued; it’s a document and a process to be avoided in order to maintain control of the “legacy project.”
   
   
        
        3. Valuation 
We were once discussing an existing buy-sell agreement with two brothers who owned a commercial construction company. The oldest brother, who we’ll call Jeff, was discussing the artificially low valuation formula in the document. He looked at us and said, “If my brother dies, I get to buy out his interest in the company for only $300,000! Isn’t that a great deal!” We said, “Yes, Jeff. But what if you happen to be the brother who goes first?” His smile evaporated quickly. Neither he nor his advisors had considered that a buy-sell agreement runs in at least two directions, and he might be the one with the short end of the valuation stick should lightening strike! A valuation number or formula should be present in every buy-sell agreement, and arriving at that number should be carefully and fairly considered. It’s a fact of life in buy-sells; one never knows just who will be buying and who will be selling! 
   
   
       
        4. Employee v. Non-Employee Owner Issues 
Many family businesses have employee family member shareholders as well as family members who are not employed by the company. Both types of owners should be considered in the buy-sell agreement. However, there is often a barrier of mistrust between employee and non-employee owners. Employee owners worry that if the non-employees get the majority of the shares in the business, they might tell the employees what to do and how to do it. The non-employee owners, conversely, worry that the employee shareholders will run roughshod over them in terms of how they operate the company or how they distribute funds. These trust and accountability issues often keep the two sides far apart in buy-sell planning. 
   
   
       
         5.  In-laws/Outlaws 
Sometimes in-laws, that is, family members who have married into the family rather than being a part of the family’s direct lineage, end up with stock in a closely held business. This may force family members to consider some very challenging real life scenarios. There have been a number of occasions where Family Business Institute clients have had as a contributing, valuable member of their family business a son-in-law whose wife was not in the direct employ of the company. In at least one occasion, the couple got divorced, and senior generation leaders had to wrestle with loyalty to the daughter conflicted with loyalty to the former son-in-law who was a valuable member of the management team. Buy-sell planning requires family business members to consider uncomfortable and difficult situations like this one, and that becomes a barrier to undertaking buy-sell agreement planning.
     
         
   

 
 

6. Decision Criteria
Few family businesses have well developed decision criteria. What we mean by that is they haven’t developed procedures that will help them decide how they are going to decide. Without solid decision criteria in place, many family businesses simply elect the easy way out and choose to either table deliberations or to make no decision whatsoever. Solid buy-sell agreements should have clear decision criteria for what corporate or owner decisions can be made by a simple majority, super majority, or unanimous consent. The absence of healthy decision criteria causes people to look at buy-sell planning with fear and loathing rather than seeing the buy-sell as a mechanism that can help them when it comes to making difficult choices in corporate governance.

   

           
         7. Unknowables  
Buy-sell agreements are typically long lasting documents. As such, they force executives to look far into the future. They may begin to think about how certain buy-sell provisions may affect their young children – or maybe even grandchildren who are not yet born! The fact is that buy-sell planning can sometimes require family business leaders to reach into the future and to drag potential problems kicking and screaming back into the present; buy-sells require that people pre-resolve problems or challenges now rather than waiting until events occur. That prospect is quite daunting for some family businesses, and the result is they avoid doing the planning they very much need to do. 
   

 
       

Given this imposing list of why people don’t undertake buy-sell planning, the following are a few tips to help readers get over these hurdles and undertake the conversations and considerations they’ve been avoiding.

 

Tip #1: Do what you can!

Don’t necessarily plan for your five year old daughter to succeed you as an owner of the company. Go with what you know. If push comes to shove, simply agree to sell your interests to your surviving partner or sibling today. That is probably what’s in the best interest of your family. Your partner will get your shares, and your family will get cash money; that makes sense. If you are concerned about your family legacy and what will happen to the five year old daughter, simply build sunset provisions into your document so that five, 10, or 15 years down the road, you and your partner will be required to come back to the table and consider new developments that may affect how the document should be written.

 

Tip #2: Don’t let the perfect be the enemy of the good

An automobile dealer was negotiating with a non-related partner, and they were hung up on a certain provision. The provision was really a niggling, small potatoes kind of item, and yet it held up the planning for over a year. Finally, in exasperation, we told them that they were letting 5% of the deal screw up the other 95%, and that just didn’t make sense. They sat back in their chairs, looked up at the ceiling, and said, “You’re right. We should move on with this thing and deal with the other parts later.” We were able to put together the deal by simply omitting the contentious provision in the short run in favor of getting the larger issues put to bed.

 

Tip #3: Pick the right buyers and sellers

Two brothers own a successful commercial construction company. Each has one son who is a valuable member of the management team and has a bright future in the company. Their buy-sell agreement, however, had, in the event of death or disability, one brother selling out to the other. This would have precluded either brother’s son, a valuable contributor to the company’s success, from owning stock. We got rid of the old buy-sell agreement and created two new buy-sell agreements so that each brother would have a market for his shares, but his son would be the buyer, not his brother. Putting the right buyers and sellers into the right places is a fundamental of good buy-sell planning.

 

Tip #4: Don’t scrimp on good legal counsel

My wife’s grandfather was known for his thrift, and he absolutely hated paying professionals for their services. Upon his death, the family was presented with the ripple effects of using cheap, inexperienced, and substandard counsel. The legal fees the estate incurred to clean up the messes created by the poor planning far exceeded what he would have paid competent attorneys to do it right the first time! How short sighted is it to avoid professional fees in the short run only to present your family with frustrations, heartache, headaches, and massive legal bills after you’re gone?

 

Tip #5: Undertake your buy-sell planning NOW while everyone is happy and harmonious

People often ask, “When is the right time to do family business succession planning?” Our answer is almost always: “RIGHT NOW!” If you wait until dispute breaks out in the family, how much harder is it going to make it to come to some understanding about a buy-sell agreement or any other family business matter? The time to do family business planning is before problems and disagreements arise. Superficially, it appears that there is no need to do that planning today; after all, everyone is getting along just fine. If you’ve been reading The Family Advisor newsletter for any length of time, you know that conflict is the rule in family businesses, not the exception. Undertake your planning today so that you’ll have difficult decisions made and a track to run on when conflict does erupt. Your family will thank you for it.

 

Wayne Rivers is the president of The Family Business Institute, Inc. FBI’s mission is to deliver interpersonal, operational and financial solutions to help family and closely-held businesses achieve breakthrough success.
September 2011