Buy-Sell Agreements – A True Story
More than a decade ago, three friends got together to start a company. They invested money and time into the start-up and got it going. Early on, they had a buy-sell agreement prepared.
Fast forward to late 2006. My friend was called in to discuss the prospects for selling the company. As part of his engagement, he priced the business for the owners, concluding that his best single-point estimate of value in a sale was $20 million for their collective equity, or about $6.7 million each. He reviewed the company’s buy-sell agreement and found a troubling provision. The agreement had a fixed price, the value of life insurance taken out on each of the owners’ lives, or $1.0 million per one-third share. This price had been set in 1994 and had not been updated since then.
Realizing the problem instantly, my friend alerted the owners of the disparity between the company’s current value and their buy-sell agreement price. If one of them should die at the present time, the estate would have an agreed-upon value of $1.0 million for an interest worth close to $7 million. To the owners’ collective credit, they all recognized the problem immediately and slowed down their sale discussion long enough to have their agreement price updated to a current value. Having done so, they’ve authorized my friend to pursue interested buyers and to conclude the sale of the business. The sale will occur or it won’t. Things happen along the way to closings. But my friend’s involvement with the owners of this company has been of enormous value to all three shareholders, regardless of the outcome.
The bottom line. Value per interest grew over time from $1 million to nearly $7 million. Had there been an untimely death of any of the three shareholders along the way, the agreement would not have protected his family. The real bottom line is that my friend’s involvement with this company has had enormous value to its shareholders, regardless of the outcome of this current sale initiative.
Reprise. Fixed price buy-sell agreements are dangerous. Let me be clear about my recommendations:
- If you have a fixed price in your agreement, revisit it now.
- If you have a friend with a fixed price in his or her buy-sell agreement, encourage him or her to revisit the price now.
- If you have a client who has a fixed-price buy-sell agreement, set up an appointment to talk about fixing the problem.