Legalmatter

By: Brian J. Meli

There’s no shortage of business start-up advice floating around the Internet. Some of it good, some of it bad, much of it downright irrelvant. These days anyone with a social media account, a flair for storytelling and a little bit of downtime can create a top-10 list of startup do’s or dont’s. Drop a few capital letters in the byline, courtesy of a degree-conferring institution, and presto! Instant credibility. 

This is not one of those advice articles.

I have no desire to tell anyone how to run their business, nor the ability even if I did. If you’re an entrepreneur or small business owner, you already have a good grasp on the basics of turning a profit. If you didn’t, you probably wouldn’t have chosen the path you did. You also understand that no two success stories are exactly alike. So trying to copy someone’s blueprint for professional success tends to be as unproductive as copying someone’s path to personal enlightenment. Sure, there are basic ground rules; some guiding principles that anyone going into business for themselves should know. But the answer to the ultimate question of profitability, the universe and everything business-related can’t be summed up in a 1,000-word blog post any more than it can be represented by the number 42.

What I am particularly interested in is making sure entrepreneurs have the tools they need to protect what they’ve already built. To ensure that all the blood, sweat and tears they’ve poured into their businesses—all those sleepless nights, lost weekends and forgone opportunities—don’t become unnecessary casualties of an unanticipated life event (read: death, divorce, disability).

Thankfully, that’s knowledge that can be imparted rather easily. Because preserving success is, quite frankly, a lot simpler than achieving it.

The offense-oriented entrepreneur

Working with small business clients, it never ceases to amaze me how extremely smart, hardworking people who sacrifice so much to build successful businesses can routinely neglect to protect the fruits of their labor from events entirely out of their control. These highly motivated risk-takers have done all the heavy lifting. They’ve quit their day jobs, invested their hard-earned money, expended their precious time and capital on an unsure thing and beaten the longest of odds. The hardest parts are done. So why aren’t these entrepreneurial types taking the time to consider how best to protect their investment? The answer, I’ve come to realize, has two parts, and the first part can be found right in the question.

Entrepreneurs are a unique and remarkable brand of people that do what they do not just because they want to, but because they have to. They possess a hunger to continually outdo themselves, and boundless energy to challenge the status quo every chance they get. They’re not aimlessly following the promise of a payout at the end of a rainbow. They’re in a high-speed race on a crowded freeway, where the goal is to cross the finish line first, and in bigger and better fashion than everybody else. The purse is important of course, but they’re in it just as much for the thrill of the chase, because it’s the chase that keeps things interesting and exciting.

And let’s face it, there’s very little interesting or exciting about planning for unknown, uncertain risks that may never materialize. That’s a theoretical exercise, and entrepreneurs above all are doers. They’re offense-oriented strivers, focused on identifying tomorrow’s opportunities. They’re not reflecting on yesterday’s accomplishments. If Alexander The Great were alive today, he’d be the standard bearer for the entrepreneurial mindset; constantly pushing, never ceasing or settling for good enough.

The second part of the answer, and this is true of all people—not just entrepreneurs—is that it’s uncomfortable to consider worst-case scenarios. No one wants to spend a lot of time pondering their untimely demise, a family breakup, or a debilitating injury, because no one wants to think those things will ever happen to him. But while it may be unpleasant, those issues are much easier to deal with when they’ve been considered ahead of time.

Learning to play a little defense

While neither fun nor exciting, planning to protect what you’ve built from exogenous shocks can be a challenging strategic exercise—something every entrepreneur can relate to. But it requires the strategically offensive-minded entrepreneur to start thinking defensively.

The centerpiece of such a strategy is the buy-sell agreement, which establishes how business interests will be affected in the event the unexpected does happen. I liken the process of creating a buy-sell agreement to playing a baseball game (arguably the most cerebral and strategic of the major sports). Your business is the team that takes the field, with each position representing a potential future outcome. Some of those positions are statistically more likely to have the ball hit to them than others, but all of them require a plan for what will happen if it is. And that plan can vary depending on the unique circumstances of each at-bat. A good buy-sell, just like a good defensive-minded baseball team, will contemplate all potential outcomes ahead of time, and know in advance what the ideal response to each will be, even if some or all of those outcomes never come to pass.

Anatomy of a buy-sell 

The bones of a buy-sell agreement are its triggers, or the outcomes that implicate the agreement and cause its provisions to go into effect. By agreeing to its terms ahead of time, the buy-sell avoids any disputes or ambiguities that may otherwise arise when a trigger event occurs. This can not only save business owners a lot of time and money, but may ensure a company’s continued survival after a tragedy. There are four primary triggers contained in most buy-sell agreements, sometimes referred to as the “4Ds”:

Death: The inevitability of death makes it the most common trigger in a buy-sell. Many a profitable business has been dissolved as a result of the death of a principal, but the untimely demise of a business partner doesn’t have to mean the untimely demise of the business. Buy-sells can determine how much a deceased partner’s interest is worth at the time of his death, and how that interest will be conveyed to his estate. A well-written buy-sell seeks to establish a balance between fair compensation for a partner’s lifetime contributions, and a payout that’s too cumbersome for a small business to bear. And, thankfully, there are several strategies for paying fair value for a deceased partner’s interest without draining the company of assets it doesn’t have, including funding through life insurance, and establishing deferred payment schedules.

Disability: While, consciously or not, death is something a lot of people prepare for, fewer tend to think about what might happen if they were to become permanently disabled. But with medical advances extending lives and lowering mortality rates, it’s an issue that’s becoming more relevant. If a small business owner suffers an injury or illness that, while not fatal, prevents her from exercising her duties, what should happen? Should she be forced to sell her interest? How long must her disability last before that happens? And how severe must it be? As with the death of a partner, there are many ways to ensure that the incapacitation of a key stakeholder does not threaten a company’s financial future.

Divorce: It’s a fact of modern life that a significant percentage of marriages end in divorce, and many of those divorcees are small business owners. A divorce causes assets to be split between ex-spouses, and when some of those assets are ownership interests in closely-held companies, personal issues can quickly turn into professional ones. If a spouse becomes part-owner of a company as the result of a divorce, must her interest be offered back to the other owners for purchase, or can it be retained? If it must be offered back, how is its fair value arrived at? If it can be retained, should that ex-spouse have the same powers as any other partner, or should her interest be merely economic? These are the types of questions that a buy-sell forces owners to ask themselves.

Departure: A better opportunity, an irreconcilable dispute, a case of professional burnout, or just a well-earned retirement; whatever the reason behind a partner voluntarily leaving a business, knowing the rules ahead of time can save a lot of time, money and headaches for both the departing partner and the remaining ones. Answering a few questions in advance of parting ways can make things a lot easier when the time inevitably comes. The buy-sell will answer questions like: can a partner sell to anyone? Should the other partners have a right of first refusal in the departing partner’s interest? Under what circumstances must the remaining partners buy out the departing partner? Can management rights be transferred to outsiders, or only the economic value of the interest?

While these are the four most common triggers addressed by a buy-sell, they are by no means the only ones. A good buy-sell will take many different scenarios into consideration; the only real limit being the owners’ ability to envision potential future outcomes that might affect their business.

So if you don’t have a buy-sell agreement in place, talk to your partners about it. It’s ok if you don’t immediately agree on all the issues. That’s to be expected. A healthy amount of debate is a normal part of the process, and will ultimately lead you to an agreement that you can all feel good about. It may be uncomfortable or awkward discussing these subjects at first, but talking about them is the surest way to cure anxiety. Then, once it’s done, you can go back on the offensive, and get right back after that next big thing.

The content of this blog is intended for informational purposes only. The information provided in this blog is not intended to and does not constitute legal advice, and your use of this blog does not create an attorney-client relationship between you and Brian J. Meli. Under the rules of certain jurisdictions, the material included in this blog may constitute attorney advertising. Prior results do not guarantee a similar outcome. Every case is different and the results obtained in your case may be different.