What's The Plan?

So you realize that you need a buy/sell agreement. You want to make sure that your spa and pool business carries on to your second and third generations without any hitches. That's a noble gesture, but have you done all the prep work necessary to draft a useful buy/sell. If creating a buy/sell agreement is like writing a novel, then most businesses write just the final chapter and hope that the foregoing chapters will just be understood. In other words, partners often draft a buy/sell without first considering the myriad real-life issues surrounding a succession plan.

A buy/sell agreement is a powerful but simple tool. All it does is transfer stock ownership upon a triggering event. What's a triggering event? Anything that can cause a disruption of ownership. Retirement is the main trigger but so are the 4Ds: death, disability, disagreement and divorce. You should draft your buy/sell to account for these issues or, if you already have one, adapt it as necessary.

What a buy/sell won't account for are the scores of other business issues such as making leadership decisions, planning buyouts, funding a buy/sell, maintaining relationships and changing family situations. Who's responsible for addressing those? As the current owner, you are. While your buy/sell is equipped to name a new owner, you're on the hook to make sure the right owner — or owners — succeeds you.

SOMEDAY, ALL THIS WILL BE YOURS The idea of a buy/sell is to keep the company intact. If one partner dies, there are usually two options: The surviving partner buys the other part of the company or a successor is named to take his place. There are inherent problems with either scenario.

Let's say you and your buddy opened a spa business in 1993. You're still single, but your partner has since married and now has a 10year-old. Look ahead 15 years: the company is thriving and the child is an employee of the company. The parent delivers the "someday all this will be yours" speech, but that's not what the buy/sell agreement, circa 2003, says. That agreement says that if one owner dies, the other partner has the right to buy out the surviving family and assume total ownership of the company, thus leaving the child out of his parent's business. This situation can be corrected easily. The partners simply have to revise the buy/sell to account for the kid.

A variation of this is when one of the partners is basically silent but inherits a company because the active partner can't or won't continue. What may end up happening is that the family of the active owner may have to buy back the shares once held by the now-deceased partner if the silent partner decides to unload his interest.

OWNERSHIP VS. LEADERSHIP So a buy/sell can say that a child will take over for the parent if something happens — death or disability. Unfortunately, the possibility exists that the kid doesn't have the same personality as the parent; he may not be ready to assume a leadership role or he's simply incompetent. The son may treat vendors poorly, his follow up with customers may be weak, and if he should take over, the other partner would be stuck with a weak link that could jeopardize the business.

In this case, succession isn't so simple. If the child isn't ready, an outside interim management team can come in to earn a "stay" bonus during the ownership transition. A stay is a percentage of the profits earned while the interim team is in place. If the child is simply incompetent, that fact must be communicated to the parent. If it can't be corrected through better training (while the father is still in charge), the buy/sell might have to exclude the son in order to keep the business afloat. If the father cannot see the professional deficiencies in his son, the business could dissolve.

CONTINUITY OF RELATIONSHIPS Overlooking the importance of relationship continuity is often the biggest mistake business owners make in succession planning. Regardless of the scenario, an unqualified leader can damage your professional ties. Employees may leave; banks won't have as much confidence in the successor and might be unwilling to lend money to allow the company to grow.

How does this happen? Usually it's because someone didn't think to bring the successor along to vendor meetings, bank meetings or sales calls early on. Or, the parent may (mistakenly) believe it's not important for his child to come along while he's still in charge.

How do you remedy this? Use common sense. Bring the kid along when he's ready to meet the people who represent key relationships. Start early to empower the successor to become a good leader. Buy/sell agreements only empower people to become owners — leadership simply can't be written into a contract.

FUNDING A BUY/SELL Buy/sell agreements should be funded, either with cash profits or with "key man" insurance. A key man policy is simply life insurance on a person who is crucial to the business. The company pays the policy premiums and is the beneficiary. If the key person dies, the company receives the insurance payoff and can use it to pay the deceased partner's heirs.

Cash may be hard to come by, especially without the services of the deceased partner. Insurance is more effective, because you're buying protection with discounted dollars. The proceeds from a policy are income-tax free. Make sure that if you purchase insurance you align the owner of the insurance with the buy/sell agreement. If partner A buys the stock, partner A buys the insurance. Get a competent insurance advisor to ask about different types of policies. If the buy/sell is funded with after-tax cash profits, it is not income-tax deductible. The company will have to generate many times the buyout amount in additional sales to cover the amount.

BUYOUTS AND FORCE-OUTS One reason you need to fund a buy/sell is to cover instances where one partner wants to leave or dies. There should also be a provision to allow a partner to cash out and exit the business if there is a disagreement. A funded buy/sell agreement should be able to cover the departure of a partner without disrupting cash flow. An empty buy/sell is virtually worthless. Not only does the company lose a leader but the burden of paying off the family then falls on the company's books. If an insurance policy isn't funded in line with the value of the company, then the family becomes a creditor to the company.

If a partner chooses to retire, the buy/sell should be structured to have a longer payout so as not to put the company in financial jeopardy. If a partner is forced out but is still entitled to a buyout (forced resignation, for example) the buy/sell should force the company to pay that ex-partner off completely or in a shorter time frame.

Regardless of whether you stay or your partner stays, the buy/sell should afford the same protections to both regardless of the circumstances of one partner leaving.

THE FOUR Ds Buy/sell agreements should be drafted when business is good. Why? Because you want the transfer of ownership to be as agreeable as you are when money's coming in. Undoubtedly, there will come a time when an argument may spark a change so you'll want decisions to have been made when cooler heads were prevailing.

Disability can be more complicated than death, and there's a higher probability that it will occur. When a frustrated partner can't work and there is no stipulation for payment, do the other partners simply buy him out even though he might be able to eventually return. Decide what you want and write it into the buy/sell before a possibility becomes a reality.

Divorce can be the trickiest of the Four Ds. In these situations, the goal is to keep your partner and separate the business from community property and the divorcing spouse. A buy/sell agreement that purports to pay a spouse fair value may be overturned if the judge declares that the agreement isn't fair or if the divorced spouse feels that the payout doesn't represent the value of the company.

POWER PARTNERS A buy/sell is an important piece of business paper, but in order to make it more effective, business partners need to be proactive in keeping it current. Obviously, a succession plan is more than a piece of paper; you can make the transition treacherous or seamless for your former partners and successors.

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