By David T. Lyons
Do you fund business buy-sell agreements? Would you like to increase the average size of your business cases? Do you have business partners? If so, do you have a funded buy-sell agreement?
The default for many of us and our clients is no agreement. No agreement is OK if there are no disagreements. The reality of business is that there will be disagreements, and there will be unanticipated events that cause someone to lose his employment and his business.
According to the U.S. Census Bureau, in 2008 there were approximately 23 million sole proprietorships, 3 million partnerships and 6 million corporations in the United States.
Many of these businesses have no business ownership agreements, and the businesses that have business ownership agreements are seldom funded. Many of these businesses have no succession plan.
These are opportunities and they are virtually unlimited. Here are some key concepts in developing the business ownership agreement.
When the owner is bought out
Assuming the new existing owner and the new employee can work out the non-solicitation/employment agreement, the next issue is determining when the existing owner is bought out.
The typical business ownership agreement has one trigger event — loss of employment. When existing owners can no longer work, the buyout process begins. Events that cause loss of employment are death, disability, voluntary and involuntary termination of employment, retirement, and expulsion. These are known as “trigger events.”
These trigger events require funding. Common products used to fund the trigger events are life insurance, disability insurance and investment funds.
An agreement will list these events and define the circumstances.
Most agreements fail to list or define expulsion as a cause to require the sale of shares. My common call is when the employer has fired his employee for cause and now wants to purchase his shares. The agreement provides only for the death, disability, retirement and first right of refusal.
The fired employee says he is not interested in selling the shares. The client is concerned that the ex-employee may be scheming to take the company away from him or is waiting to collect on the life insurance used to fund the agreement.
The omission to cover the expulsion was a critical mistake by the advisor. What solution would you propose?
There is no requirement to buy or sell the shares by the company or the shareholder unless specified in the agreement. The hope is that the ex-employee is financially stressed and will sell the shares at a fair price and fair terms. This is an excellent opportunity for you to bring attention to your personal business agreement to your clients or potential clients.
If you work with a life insurance company that provides specimen documents, what does the specimen document list as a trigger event?
The rogue employee
A typical rogue employee trigger clause is “employees engaging in any competing business, engaging in acts of insubordination, and otherwise failing to expend his or her best efforts on behalf of the company or otherwise failing to devote his or her full business time.”
A simpler way would be to require employment by the company as a condition to own shares.
The effective date of the trigger event is defined as the date the employee stops providing services to the company. That prevents the employee from not coming into work but still demanding a share of the profits. The trigger event is the date when all future profits, distributions, and voting rights shift to the new owner.
Besides the rogue employee who doesn’t want to sell his shares, what about the rogue owner who fires the employee without cause and keeps his life insurance as a company asset?
Most agreements do not have a safeguard to provide that the policies used to fund the agreement will be returned to the individual whose life was used to insure the agreement. There is no requirement to return the policies owned by a company to the insured unless specified in the agreement.
A typical return-of-insurance clause is “the company shall transfer any policy, or any interest in any policy owned on the life of a shareholder, or any disability policy, to the insured shareholder for the interpolated terminal reserve value of a life insurance contract within 60 days of the day termination of this agreement and completion of all required payments.”
David T. Lyons, J.D., CPA, is a shareholder with the law firm of Lyons|Sullivan, Bellevue, Wash. His specialty is business, estate and tax planning for successful individuals, and his main source of clients is insurance agents and financial planners. The comments above are excerpts from his address on “The Key Concepts of Business Ownership Agreements” at the 2015 Million Dollar Round Table annual meeting in New Orleans.