Earlier this month I had a call from Steve. He had been speaking with his friend (Jodie) whose business partner had died recently in a motor accident, leaving her and the business in a tricky situation.
Jodie and her business partner, Claire, were building a successful fashion label. Claire looked after the finances and marketing, whilst Jodie provided the creative spark.
When Claire died, all of her interest in the business went to her estate and her family just as it was set out in her Will.
Jodie no longer has a person who really knows the financial workings of the business and her new partners (who are now Claire’s adult children) do not have the skills to contribute to the business. But they are still entitled to be paid.
The passing of Claire has not only affected Claire’s family, but it’s also taken a toll on Jodie. The stress of keeping all the balls in the air herself is impacting her ability to do her job well and maintain that creative spark.
So what should Jodie do?
The obvious answer is for Jodie to buy out the new partners before they sell to a complete stranger. However, even though the business has thrived over the last three years, Jodie cannot raise the money needed to fund the buy-out.
Steve wants to know how he can avoid being in a similar situation if one of his business partners were unable to contribute to the business through accident or illness.
Fortunately there is a solution, known as a Shareholder Buy Sell Agreement, which generally forms part of a corporate succession plan.
The thrust of the document goes like this. Each of the shareholders in the company (this will also work with a partnership) agree that upon certain trigger events (such as death, permanent disability or some other event) the remaining shareholder have the right to exercise an option to purchase the shares of the deceased or disabled shareholder.
The buy-out is funded by insurance proceeds, as each shareholder or partner is required to maintain an insurance policy that benefits the remaining shareholders, should a trigger event occur. The insurance funds facilitate the buyout provisions.
Steve and his partners can define trigger events as they see fit. For example death or total and permanent disablement are the obvious choices, but you could also include other major illnesses such as stroke or cancer.
A Shareholder Buy Sell Agreement would have helped Jodie with the funds she needs to carry on the business and employ someone to keep track of the finances and marketing.
Of course one needs to review this arrangement from time to time to ensure the valuations of the business reflect the valuations of the insurance policies. It also gives the partners an opportunity to plan for the unexpected and ensure that the business stays on track should a trigger event occur.