Bob, Carol, Ted, and Alice are all equal partners in a thriving restaurant here in the lovely Santa Clarita Valley. Things are dandy until they are not.
First, Ted dies. He and his wife, June, had five kids. Unfortunately, June passed away before Ted.
Carol wants to divorce her husband, Fred. The challenge there is that Fred will not go quietly.
Bob recently learned that he has prostate cancer and will be unable to work for six months or longer.
There’s nothing wrong with Alice, other than the fact that everything is screwed up with her partners.
In his estate plan, Ted left his ownership in the restaurant to his five children. Three believe that things are great, and nothing should change. Two are vegan and demand that the restaurant become vegan as well.
Fred is looking forward to owning half of Carol’s interest in the restaurant. He sees it as an opportunity to make an easy salary and to cozy up to some of the cute waitresses.
No one is sure what to do about Bob and his medical condition. Does he stay involved in the restaurant? Does he continue to receive a salary?
The courts are full of similar cases where poor planning has left the owners of a business in the lurch trying to figure out what to do. And so many of these challenges can be avoided simply by making some decisions now, rather than waiting until the inevitably bad event occurs.
A buy/sell agreement for corporations or an operating agreement for LLCs can address many of these difficulties and uncertainties.
Now, a buy/sell agreement is not the agreement where a business is purchased or sold. Rather, it is an agreement between the owners of the business about any number of issues. These issues can include what happens when a co-owner dies; what happens when a co-owner becomes seriously ill; what happens when a co-owner decides to sell his or her interest in the business; what happens when a co-owner gets a divorce; what happens when a co-owner does something that really hurts the business, like being sued for sexual harassment, being addicted to drugs, or being convicted of a felony.
So, let’s take a look at how a buy/sell agreement could resolve the issues raised in our hypothetical.
In Ted’s case, the agreement would outline what happens when a co-owner dies. Is the corporation and/or the remaining co-owners obligated to buy Ted’s interest in the business? Or, rather than being mandatory, is it optional? In either event, how is Ted’s estate paid for his interest in the business? Life insurance can be a partial or whole solution to that question. Also, are any of the co-owners allowed to transfer their ownership in the business either while they are living or as a result of their death? If the buy/sell agreement had prohibited Ted from leaving his interest in the business to his children, then that would have prevented the confusion caused by the involvement of his five kids.
It is always crucial that the buy/sell agreement address what happens when a co-owner gets a divorce. Generally speaking, the agreement would require the spouse of the co-owner to follow the buy/sell agreement. The buy/sell agreement will provide that upon a divorce, the co-owner and his or her spouse will agree that the spouse will sell his or her interest to the co-owner at a price outlined in the agreement. This would prevent Fred from using the restaurant as a target-rich environment for his amorous adventures.
Finally, in the case of Bob, the buy/sell agreement can discuss what happens when a co-owner becomes seriously ill. Is the co-owner going to be sick for a long time? Will the co-owner be unable to contribute at all to the ongoing operations of the business during this time? Does the fact of the co-owner’s illness trigger an option for the other co-owners to buy out the sick one?
The operating agreement for an LLC will address many of these same issues, as well as operational questions such as who has authority for what and how much money does each co-owner have to contribute to the business.
Getting the co-owners together to find agreeable answers to all these questions now will ease the transition when many of these inescapable things happen. ©
Carl Kanowsky of Kanowsky & Associates is an attorney in the Santa Clarita Valley. He may be reached by email at firstname.lastname@example.org. Nothing contained herein shall be or in intended to be construed as providing legal advice.