• 1-833-429-1190
Kevin-Barry Henry

How to Protect Your Family in Your Business Partnerships

Lately, I seem to be getting a lot of questions related to business partnerships and buy-sell agreements. As our post-covid (hopefully) world and new gig economy has people ditching traditional employment to strike out on their own as contractors or open their own businesses, it becomes very important to protect yourself and your family and your interests. A buy-sell agreement is a tool that protects each member of a partnership in case something happens to them. They are very important, as you can imagine.

Buy-Sell Agreement

A good buy-sell agreement contains a minimum number of key points. These would include:

  • What occurs on the death of a shareholder?
  • What occurs on the disability of a shareholder?
  • What happens if there is a disagreement between shareholders?
  • What happens if one of the shareholders divorces?
  • What happens if one of the shareholders declares bankruptcy?

When a shareholder dies prematurely, the agreement should specify how the deceased’s shares are to be handled, whether redistributed amongst existing shareholders or redeemed.

The key issues to be included are price, timing, and taxation. The valuation of the share price could either refer to a specific formula or refer to a third-party evaluator. Timing would address the maximum period of time for the redistribution or redemption to be completed. Taxation should refer to the use of any method that would increase the tax efficiency of the transfer, particularly the use of the Capital Dividend Account. Some, but not all, buy-sell agreements address the ownership of life insurance in this section. It could set the requirement, of who will own and who will pay for coverage.

For many of the buy-sell agreements, dealing with the death of a shareholder is quite common, however, many agreements do not deal with an extended illness of one of the shareholders. If the ability of the shareholder to participate in the business is compromised, the remaining partners may feel the distribution of profits to that person is unfair. On the other side, the illness may require additional cash needs for the shareholder who is ill and selling his shares may be necessary. So, addressing this issue in the buy-sell agreement can circumvent rash decisions and bad feelings among the shareholders. There are several carriers that offer disability buy-sell coverage, and the policy and agreement could be structured with a payout over a period of time to minimize the cost of the coverage.

Shotgun Clause

A third area where a buy-sell agreement should come into force is through the use of a disagreement clause, otherwise known as a shotgun clause. What this clause does is protect one or more shareholders from having their shares taken over by other shareholders. For example, if Shareholder A wants to get control of Shareholder B’s shares, but Shareholder B does not wish to relinquish control of his shares, Shareholder B can reverse the demand. This would mean that Shareholder B is now able to purchase Shareholder A’s share at the price originally offered by Shareholder A, and Shareholder A is obligated to sell at that price. This is where the name shotgun clause is derived. This is a way to avoid hostile takeovers.

Divorce

The next area where a buy-sell agreement is important is to protect one owner’s share from becoming part of a divorce settlement and ending up with a partner not desired (the ex). Some verbiage requires the shareholder to sell his interest back to the corporation or another partner at a predetermined price, based on a valuation clause. There should be some guidelines outlining how frequently and by what method shares are evaluated. Once this is in the agreement, there is less potential for further disagreement.

Bankruptcy

One final area of contention between shareholders is if one of the shareholders declares bankruptcy. Again, a bankruptcy clause could be included in the agreement which would prohibit the bankrupted shareholder’s shares to be included in their assets assigned to the Trustee. Instead, the shares would be redeemed by the corporation or other partners, and the proceeds of the sale would be assigned as bankruptcy assets.

All the clauses referenced above are very general in nature and cannot be applied to a buy-sell agreement, except in very general terms. You will see that there is much overlap between shares and how they are dealt with if the situation arises. The clauses can get extremely specific, which would very narrowly define when and where a particular clause may be used. For one example, recently we heard of a buy-sell agreement that explicitly excluded a shareholder to maintain ownership of his shares if they were found to be continuing to use narcotics. Obviously, in this case, the individual had a history of past use of narcotics so if it were found he was continuing to use these drugs, his ownership claim would be discontinued.

Specific Clauses

I have not included very specific examples of what a particular type of clause could look like. The reason for this is if a clause is taken verbatim from another shareholder’s agreement, it could create problems if the two clauses are so similar that they do not perform the duties they are meant to perform. You will have seen that clauses in a buy-sell agreement can cover a great deal of subjects and can end up causing more harm than good. The most important suggestion I can make is to have your agreement drawn up by a lawyer or accountant who specializes in this area.

While some of the above discussion does not relate directly to the services we can provide (get a lawyer), it does allow you to (hopefully) build your knowledge to have a broader discussion with your partners and commit to reviewing insurance solutions related to the buy-sell agreement. Of course, if no agreement exists – and you may be surprised to find how many businesses have never completed such a document – you will have the tools to start the discussion.

If you would like to discuss protecting your business or your family feel free to reach out to me for a free call or zoom meeting here: FREE 15 MINUTES

As always, I look forward to your questions and comments.

With Gratitude,

KB.

Join My Newsletter

THIS ARTICLE IS PROVIDED AS A GENERAL SOURCE OF INFORMATION ONLY AND SHOULD NOT BE CONSIDERED TO BE PERSONAL INVESTMENT OR LEGAL ADVICE. READERS SHOULD CONSULT WITH THEIR FINANCIAL OR LEGAL ADVISOR TO ENSURE IT IS SUITABLE FOR THEIR CIRCUMSTANCES.

, , ,