Smart Business: Partnership Prenups (Leadership and Management)

[Leadership and Management]

Smart Business: Partnership Prenups

Hed: Planning on Partnering Up? Don't Forget the Prenup.

Deck: Partnership Exit Planning: Buy-Sell Agreements

Summary: What happens when a business partner dies, or simply wants out of your company? A well-drafted buy-sell agreement can make this transition a successful one.

Pull quote: "By getting a buy-sell agreement in place a client saves potentially thousands or tens of thousands of dollars down the road in litigation expenses."

-- Steven Dubner, attorney, Higgins & Dubner

Many companies are founded on lots of optimism and make no plans for the day a partnership splits up.

Who will take control of the company if a partner dies? What happens when an unhappy partner decides to sell his shares of stock to competitors? How can the other owners stop the sale? The answers to all those questions should be found in the same place: the partnership's "buy-sell" agreement. Having one in place can save businesses lots of time, money and aggravation.

Bernie Meineke, director of the Small Business Development Center at Georgia State University (GSU) in Atlanta, cautions that stinting on legal costs at the launch of a business is a dangerous mistake. He and three full-time consultants handle some 500 cases a year, helping startups and existing businesses by providing information, ongoing consulting, and adult education seminars.

Meineke believes it's essential to get legal advice, but it doesn't have to cost a lot. If people come in prepared, a good attorney can help them navigate the murky waters of doing business in today's fast-paced environment.

What Buy-Sells Do

Whether a company is a simple partnership, a limited liability company (LLC), or a corporation, a buy-sell agreement is a binding contract among the business owners that controls the buying and selling of interests in the business. A good buy-sell agreement will make provision for a withdrawing partner, or the estate of a deceased partner, and will pay the value of the partner's interest in the company over time. For example, a life insurance policy owned by the business can fund a purchase in instances of death, or its cash value can be used as a down payment for buying out a retiring party.

There are four basic types of buy-sell agreements:

* Entity Purchase Agreement, in which the business is obligated to purchase the shares of the deceased or departing owner.

* Cross-Purchase Agreement, in which the remaining owners must individually purchase the interest of the departing owner.

* No-Sell /Buy-Sell Agreement, which allows existing owners to keep control of the business and allows the departing owner or heirs to benefit from the business' prosperity.

* Wait and See Purchase Agreement, which gives the business the ability to decide on whether to employ an Equity Purchase or Cross Purchase Agreement at the time of a triggering event.

Crafting a buy-sell agreement doesn't have to cost a lot, says attorney Steven Dubner of Higgins & Dubner in Atlanta; you may get away for as little as $200-$300. "The way I view it, it's preventative maintenance," Dubner says. "By getting a buy-sell agreement in place a client saves potentially thousands or tens of thousands of dollars down the road in litigation expenses."

Considering the modest costs involved, why don't more people create buy-sell agreements? Both Dubner and Meineke cite ignorance as a factor: People simply don't know about such agreements. Another reason is that there seems to be a psychological reluctance to deal with the disagreeable aspects of a business. Like prenuptial agreements for marriages, people don't want to plan for the worst, or even the inevitable -- and especially not the downsides that can come with success. A third reason: A buy-sell agreement is not a tangible expense, like a photocopier or computers, and therefore does not seem warranted.

What Happens Without One

A man we'll call Peter Trapper -- he prefers that he and his company not be named -- is a New York Web site producer and strategist. In 1997, he and some friends started a Web company. Eventually they incorporated, using a book as a guide, but neglected to draft a buy-sell agreement. Like many entrepreneurs, Trapper worked long hours for little money to grow the business. Eventually, he had a parting of the ways with the CEO and wanted out. He left the company, but remained a shareholder.

A year later, the company hit it big, and now makes almost $10 million dollars a year. With success came the move to force Trapper to sell his shares for what he calls "a pittance." A legal battle ensued that lasted more than a year. The parties eventually reached a settlement, but no one was particularly happy with it.

Says Trapper: "The lesson is that buy-sell agreements are absolutely crucial and that going into business without one is just begging for trouble. Situations always change, and the only time that (the agreement) won't come up is when the business is not successful."

Shootout at the Buy-Sell Corral

Sometimes having a buy-sell agreement can lead to some dramatic outcomes. Attorney Dubner tells of several shareholders in a corporation who wanted to get rid of one partner. They took advantage of a "shootout" provision in their buy-sell agreement to put forth an offer to buy out his shares at an unreasonably low price.

Under the terms of the agreement, the lone shareholder could either accept the low buyout offer, or force the other shareholders to sell their stock back to him at the low-ball price they had offered.

In the end, the partners were outgunned. The lone partner got financial help from an outside party and forced the other shareholders to sell out at the undervalued price. The shootout provision brought a component of fairness to the table that would not have been there if the buy-sell had not been in place.

Things to Remember When Drafting a Good Buy-Sell Agreement

* Owners need to establish the value of a business to ensure a fair payout to the estate of a deceased partner, as well as setting an amount that will be affordable for the buyers and the business. Many buy-sells include a clause that requires revaluing the company on an annual basis.

* Life, whole life, and disability insurance policies are often used to fund payments for death, disability, retirement and the early departure of an owner. It's important to make sure there's adequate coverage to meet the specific needs of a company. Owners can also draft payout terms -- such as spreading payments out over a ten-year period.

* Triggering events will bring the buy-sell agreement into play, including death, disability, or the retirement of an owner. Other triggering events to consider adding: divorce, bankruptcy, creditor's judgment against an owner, conviction of a crime, loss of a professional license, and a third-party offer to purchase.

* Include a mandatory buy-out of a departing owner's interest, so a market will exist for the owner's shares. This also protects the business from having shares sold to undesirable partners or competitors.

Many available resources can provide practical guidelines for developing a good business model, including How to Create a Buy-Sell Agreement & Control the Destiny of Your Small Business by Anthony Mancuso and Bethany Laurence (Nolo Press, 1999). The book is written for lay people and includes tax and legal information for small business owners.

However, Dubner and Meineke still believe people need to finalize agreements with an attorney. "Don't do your own incorporations," says Dubner. "The costs of incorporating through a competent attorney are so low, why jeopardize this limited liability protection by trying to do it yourself?"

SOURCES:

Bernie Meineke

Director, Small Business Development Center

Georgia State University

University Plaza

Atlanta, GA 30303

(404) 651-3550

email:

Steven Dubner

Attorney, Higgins & Dubner Law Firm

3333 Peachtree Rd.

Suite 230

Atlanta, GA 30326

404-264-1011

email:

"Peter Trapper" [this is an alias. The real source's name is Jon Freed]

web site producer and strategist

369 14th St. #2

Brooklyn. NY 11215

718 832 1914