Why your family-owned business needs a buy sell agreement

A buy sell agreement is important in a family-owned business as it specifies the parameters of the transfer of ownership. Some partnerships and LLCÂ’s contain a buy sell provision but many Articles of Incorporation do not. Thus, in the case of a corporation, it is up to the shareholders to be proactive and formulate one.

Absent a buy sell agreement, ownership transfer may occur in the emotion of the moment rather than according to any agreed to principles. This absence may prevent the dissolution of a difficult business relationship because conditions are not specified by which someone can dispose of their ownership. This may result in a stalemate. The lack of specified procedures can be doubly painful in the case where a family owner has died, leaving the grieving spouse to negotiate with the remaining family owners. When this happens, the inevitable difficulties of working out the disposition of the survivorÂ’s ownership makes a hard situation even worse. One funding option is life insurance, which can be purchased by the corporation or by each owner taking out a policy on the others. Having pre-agreed to principles regarding the transfer of ownership is one more tool to promote harmony and ensure the success of the enterprise. 

The agreement should be balanced between the needs of the company going forward and those of a departing participant. However, as a rule of thumb, the ability of the enterprise to go forward must receive a high priority.

The process of working out the buy sell agreement often triggers productive conversations among the family members that gets them to focus on a multigenerational perspective. A number of issues should be covered in a buy sell agreement. They include:

1.  Who can be an owner?

2.  What are the “trigger events” for ownership transfer, such as death, disability or redemption?

3.  How shall an ownership position be valued and what are the terms of purchase?

Some of these questions have better answers than others but there are no “right and wrong” responses. It is pretty much whatever everyone determines works best in a particular family.

The question of who can be an owner addresses how narrowly or broadly people can participate in the enterprise. The challenges of managing the ownership increase geometrically as the heirs increase in number and diversity. Limiting the breadth of this progression make sense from a business standpoint but may be a tough sell to a family member.

Some ownership transfer triggering events are straight-forward and some are not. In the case of death, the most challenging question is whether the departed ownerÂ’s family can inherit his or her ownership or if it should come back into the fold. Another potentially vexing area regards whether someone can force the company to redeem some or all their shares. A negative answer to this point or not addressing it runs the risk of “trapping” someone in their investment.  Typically, if this happens, it is a seed of great trouble down the road.

In privately held companies the valuation process may not seem to produce a number anywhere near the “full value” of the stock. This difference may occur for estate tax purposes, but it also can happen because the people who control the process don’t want to pay out more than they have to in a redemption situation. A generally reliable method is to establish a valuation process that can withstand public scrutiny and is fair.

In a public company, the transfer of ownership provisions are extremely important because the control of the company could be placed in the balance by family members selling their shares to non-family parties. The valuation formula is less important because the public markets take care of this point.

Another issue families have to sort through is whether the company has the first right of refusal if stock becomes available, and is he company obligated to purchase this stock? How should the purchase be funded and on what terms? 

It is important to underscore the necessity of having all these contingencies worked out before they occur so resolutions can be reached in a calm and thoughtful manner instead of in the heat of the moment.

Co-authors Sam H. Lane and Ellen Barnes Pfiffner have a

combined 50 years of management consulting experience with a multitude of Fortune 500 companies as well as with owner managed and family owned businesses. As a corporate psychologist specializing as a consultant to family business, Lane creates and implements individualized approaches to the unique challenges faced by family business enterprises. Also an in-demand speaker, Ellen Barnes PfiffnerÂ’s hands-on business experience spans organizational development, sales, marketing, operations and corporate training.