Buy-Sell Agreements: What Every Business Owner Should be Thinking About

Speaker 1 00:12 Hey, good morning, Modesto and Stockton in surrounding areas. This is Leo. And here you’re listening to business and legal talk with Lee and Claudia. Good morning, Claudia. Good morning. How are you? Oh, I’m doing swell. I have to high on coffee. Oh my goodness. This is Saturday morning. It’s a beautiful day. I’m a, I’m a hopeless positive person. Absolutely. And I’m happy to be back with another great show for you guys. Yes, it’s going to be really good. Today is super, super exciting. I can’t wait to, well, do you want to tell us what we’re going to talk about today?
Speaker 2 00:44 Yeah. We’re going to talk about buy, sell agreement. I know when you hear the excitement you need to, it’s something that every business owner should be thinking about. Your months ago, I think, or I would say weeks ago, we did touch on the idea of structuring your business so that you could sell it. Um, this is going to kind of follow along with that, but it’s not necessarily so that you could sell it, although that is a fine idea. Right? This is kind of a hybrid of that. So that we can, you know, take, make provisions for the business is, should something happen. Um, and we ended up exiting the business for some unknown reason. So we want to have something in place that’s really kind of a practical thing that business owners should be putting in place so that we can protect ourselves and then the business doesn’t just disintegrate. Should we exit for some reason and be incapacitated or die or, you know, whatever I’m trying to avoid. I’m trying to avoid going down that dark road, but, you know, it’s, um, it’s a preventative measure. Um, and it’s something that that should be considered all the time.
Speaker 1 01:47 So I know it, once I started on that topic, we probably gonna have a hard time getting off the topic, but, so let’s just, that was some fun stuff. Easier things, right? Um, I like to start this segment now with just some more like, I call it corporate gossip, right? Or just fun things that are not necessarily on topic, but I think as a business owner, you, you, you, you, you get a kick out of. So, Hey, so I found this thing that kind of gives me news through LinkedIn, you know, a corporate news if you will. Right. But, um, I was listening, I was just reading this article. Um, and if it is in LinkedIn, it must be true. Well, uh, many new fathers are still hesitant to take prolonged time of war, four far for fear of harming their careers. Hey, how bout that? So many new fathers are still hesitant to take time off work for fear of harming their careers. This is even though companies are offering more and better paternity leave, however, I report in the wall street journal highlights a company whose founders both took three months of paternity leave at the same time despite the corporate and cultural taboos, while their ashes increased the workload around the office, employees said that said that the example set by the bosses resonated. I mean, what do you think about that? I don’t know.
Speaker 2 03:07 I don’t know. You, you would think what is like taking time off? Well, yeah, I mean, and I, and I suppose it’s the same kind of quandary that we are all in, is that it’s, it’s hard to take time off and get disengaged and then turn around and come back and be re-engaged. I ended up taking three days off for the Memorial weekend. Right. And that was the first, um, days off that I had taken. And I think the count was like 34 days or something. Like w I just kept working through the weekend and got to a point where I’m super burnt out, but you’re afraid to walk away for that long because then you have to come back. And that Tuesday was a little bit of a challenge as like, wow, I’m back. Okay. The thing thing. And so I think part of that statistic I think is probably wrapped up in that idea.
Speaker 2 03:56 Um, and that we as a society, we, you know, we were really hard workers. I mean, it’s just our American culture by and large, uh, you know, hard workers. Um, so particularly business owners, um, you have a hard time letting go and walking away. So, um, while I can understand men being a little hesitant to take it off, I would, I would have to guess that it’s not just because they are concerned how it’s going affect them, say what the boss or the company. But it’s also that walking away is for a length of time because when you go off on maternity leave, you’re gone, you know, six weeks completely disengaged. Right. And that’s a little bit of that. I, I,
Speaker 1 04:38 and you want to hear something? You want to hear something funny and ready for a laugh. So I got an email from a buddy of mine who is an insurance professional and he said he was at a restaurant in Fresno and overheard a few millennials have in their lives on a Friday night talking about, you know, the challenges of their age group, right. Millennial. And one of them was bragging, Oh my gosh, I’m so busy. I’m clocking at about 30 hours a week of work. What? So when he shared that of phase, well actually he shared on Facebook and he’s my friend, so I saw it and I would literally, that was, I said that would be two and a half days for me or two days. Right. But this person was actually bragging about the fact that they were actually working 30 hours, which is the legal definition of full time to get some benefits and some companies. Right. But does that tell you something about the generational gap?
Speaker 2 05:30 No, I think it just, I think this person was probably just young because we were all there to some point when we were young, but then life hits, yet we’re still young, we’re still young. But like life hits you along the way and you start to figure out, Oh, wait a minute, wait a minute. If I want that car or if I want that house, if I want to grow up and maybe I want a vacation, I need to start getting in the groove. And then there’s those of us who find we enjoy the process. I, I would, I would work for free. I would, I would work. And I would not charge anybody because I love what I do, but I still need to pay the bills. So unfortunately, clients who may be listening, I’m still have
Speaker 1 06:09 I’m sorry. Yeah. You still have to pay to they’re you’re client. You gotta pay to Claudine. That’s right. Yeah, unfortunately. But, but I think what you’re talking about is really very 70 I’ve read articles, the 70% of the workforce wishes they were working elsewhere or doing something. Really. Yeah. Well that’s super sad. So for you to say that you could do what you do for free. Oh, absolutely. The fact that you found your passion absolutely to you. Yeah, absolutely. I am absolutely convinced myself that I am doing what I was born to do and I can help it. Right. I don’t know when to stop working and have people call me and I’m hitting in, you know, my wife sometimes gets upset because I give the too much knowledge away. You should be charging for this knowledge, but I love doing what I do. And, and yes, we had to take care of our families. But back to this whole thing, you know, I thought it was funny, I wanted to share it. Hey, so you have some legal briefings, some stuff that you, uh, yeah, you know, stuff
Speaker 2 07:06 the, we have talked about, um, you know, wage hour law and the lawsuits that come along with it. And I actually read this, um, was reading, uh, a settlement that that was a, uh, tentatively agreed to that’s going to be proposed to the court, um, on a lawsuit that is extremely common. This, this is extremely, extremely common as a wage hour lawsuit that has, um, elements of overtime, um, or not non-payment for overtime as well as not getting your, um, meal and rest breaks. So that is the vast majority of, of wage hour lawsuits that are filed by employees are over not being paid correctly and not getting your meal and rest breaks. So, um, 1.2 $5 million settlement was agreed to by a childcare chain, um, that has about 1600 employees and the, um, they’re settling out of, um, before they go to trial. Of course. And they, they had 1.25, 1.25 is the settlement, the distributor about how many miles, how many employees?
Speaker 2 08:17 1600. Oh, all 16. Okay. So yes, because um, and I don’t think, I don’t know if we’ve talked about on the show before, but there are what is referred to as lawsuits are private attorney general act, um, of 2004, which allows an employee to Sue on behalf of other employees. Um, and they stand in the place of the attorney General’s office and then so they also have their lawsuit going. So it’s like, it’s essentially a double class action. Um, so anyway, the settlement came down at 1.25. How much do you think the attorney’s got of that?
Speaker 1 08:52 Okay, hold on. I’m done. Some numbers right now divided by 16 employees. So what I can be right, one, two, five you know, divided into 1600, $781 per employee, but okay. That would be, Whoa, that would be the entire amount. Minus 40% of the attorneys. Right.
Speaker 2 09:10 That what’s going to the attorneys is 492
Speaker 1 09:15 thousands okay, so four 92 divided into one, one to five
Speaker 2 09:21 and then they’re, you know, there’s a 75,000 is going to the um, California labor and workforce development agency because her suing on behalf of the, the attorney General’s office and the labor labor board. So how much the attorney gets? Four 92
Speaker 1 09:38 so that divided into one, one, two, five, that’s 43.7%
Speaker 2 09:43 okay. And that includes some out of pocket costs that the attorneys have fronted as well. So it’s not just, it’s not just the legal fees, but the workers are going to split 620,000 and then we have some various costs for administrative fees and so forth. But these, you know, this, this is a call to employers all over to ensure that your employees are being given rest breaks and meal breaks, track it, come up with a way so that you’re monitoring this because these things are, you can defend these cases.
Speaker 1 10:16 Wow. Well. So this is just one little tidbit of juicy legal stuff and hold your thoughts. Are you, so you’re listening to business, illegal talk. We have to go to break. Stay tuned. We’ll be right back. We’re talking about buy, sell agreements. Stay tuned.
Speaker 0 10:28
Speaker 1 10:54 alright, welcome back. Are you still with us? I am. Well I’m, well yeah, I know you are. But talking to our audience, are you still with us? This business of legal talk were still, Leo was still Claudine and we’re talking about, Hey, the things that mattered to you as a business owner and that is our audience and here in the central Valley. And we were talking about buy, sell agreements. So let’s kind of get into it now. Okay, so take us there.
Speaker 2 11:18 So buy, sell agreements are just a way of kind of forward thinking. Um, a lot of what F’s. Um, if you’re in a partnership, you should or if you’re in a corporation that has multiple shareholders, absolutely should have some game plan for what ifs. So what if one of the shareholders, or what if your business partner dies and those shares are an asset that can be transferred and will be transferred through the deceased estate so the air can become the owner of those shares. So you may ultimately end up being in partnership or in business with the heirs of your partner. How often do you run into that, that there is no buy, sell agreement between at least two owners? Oh, most all the time.
Speaker 2 12:13 A lot. A lot. I would say. I would say probably I would say gotta be 70, 75%. Gotta be, we’re real good at setting up the corporation, getting the bylaws done and all of that agreement we should do at, at, at the outset. But a lot of people are, you know, a lot of tax tax, uh, folks are setting up corporations for their, um, clients and they filed the articles of incorporation and so forth and they kind of do the initial stuff. Um, but I don’t see them, you know, getting into the buy sell agreements. Those are kind of, that’s when you start to kind of step over and you’re practicing line and you should have some contract experience and so forth. So you should absolutely have in place because you could wake up and be in partnership with or an an ex. What happens if your partner divorces and his ex wife or her ex husband says, wait a minute, I want part of that company.
Speaker 2 13:08 You own 50% of that company and I’m entitled to my share of community property. That’s correct. That’s correct. If there was a prenuptial in there’s a hole that’s correct. And that, and that sentence, a know the TV show, it’s a whole nother TV show for sure. But buy, sell agreements or something that can can be done easily. Um, it doesn’t have to be extremely complicated. What we need to do is figure out w what is it, what is the agreement. So if you and I are in business together and uh, we set up, um, an arrangement that says if I died tomorrow, so this is how a very common way to set it up. If I died tomorrow, you, the company is paying life insurance on you and life insurance on me canceling insurance. So if I die, the life insurance goes to my heirs in exchange for the shares that my heirs would be entitled to or the shares go to you directly.
Speaker 2 14:06 And the, you know, the, the cash goes to the air life insurance or we split the life insurance because when we lose one of our partners, we lose a revenue generator ideally. And so some money stays within the corporation so that the corporation can sustain itself in and take the hit of losing one of the partners and some money goes to the family or some money. Does it have to, it’s a contract. You can do it any way you want. You can also, um, create, buy, sell agreements with people outside of your business. So for example, if I, um, could create a buy, sell agreement with another law firm, another attorney in town and say, Hey, if I died tomorrow, you get my files, you get my whole entire business. And um, you know, huh? We create, we create the price today. And maybe we reevaluate it every three years or something like that. But essentially we create a contract today to resolve that problem for tomorrow.
Speaker 1 15:06 Wow. Oh wow. So I mean, I’ve got a lot of, um, you know, I did some research, I was actually that researchers for these shows research. But I thought, I always knew that you were the one. So if I am a business owner, so the obvious one is death, right? What are the triggers, uh, when you sit down with your, uh, the potential things that can happen, um, and how do you factor valuations of and why, how do you go about it, I guess? So found these articles, six things to know about buy, sell agreements. Um, you want to walk us through that and what are some of the assumptions are, go ahead. So it says here they should be developed early. I think you just covered that, right? Um, he says buy, sell agreement shooting through a business valuation cross.
Speaker 2 15:54 Absolutely. And that, that, just to define it, cause you know, I like to define things, so we’re all on the same page. And that is really, um, the clause of how do we evaluate the shares, what methods do we use? And you can probably explain the various methods, um, but there are mult multiple different types of ways of evaluating the business. So,
Speaker 1 16:17 okay, so let me chime in. So there should be a mechanism and if you’re going to really, we’re gonna throw the word valuation out there. It shouldn’t be thrown lightly. Um, it’s, if it, true valuation involves outside parties who are competent and experts in the subject of valuations that are going to do this. Gary comprehensive, uh, it’s like an appraisal. Okay? It’s no different than if you were going to purchase or sell a home. You want an appraiser appraising the house, right? And this appraiser would have a license and they would have to go through a, say 150. I’m just guessing point inspection. I struck structurally the foundation of the house and go through these checks and to arrive at all the, you know, the comparable comp and the comps in this similar houses in similar makeup and the, and the, the, the roof where there’s , all of that is gonna spit out at the end a evaluation of the house, which is an appraisal of the house, which really is a guess right at the end of the day.
Speaker 1 17:12 Right? But it is a guess based on a professional who knows what they’re doing or we hope they know where they’re doing and, and there are software that does that. So the same happens for a business. I’m only using the real estate because it’s something that everybody knows, right. But it’s a little more gray on the business side, but there are still some ways that if you really gonna do it right, you would want to hire a third party valuation or like a, whether it is a CPA firm or a, a financial firm who has an expertise in valuations. But to keep us simple, I would a business owner, you have to come to an agreement together at what the businesses worth. And there’s a couple of ways we can do that. One, we can say a multiple of you know, one times revenue or 1.25 and it could be depending on the industry, right?
Speaker 1 18:06 If businesses, what are similar businesses and similar industries selling for, well there’s businesses usually sell on a multiple of revenue and multiple of earnings or EBITDA, earnings before interest, taxes, depreciation and amortization or a multiple of discretionary cashflow, which is you know, the income plus all the owner related expenses that get add into the P and L to lower your income tax. Got it. So that spits out a number, right? Um, discretionary cashflow, which is like when you are the owner and all these things, basically you expense things throughout the business that you’re legally allowed to write, which you actually make a lot more money where your net income says, right. Those are this people can play around with,
Speaker 2 18:50 let me tell ya that that are the source. You want to see a source of a fight is that it’s going to be that because the spouse, let’s say for example, we have some, a spouse that passed away, um, and this, the spouse that is deceased was the shareholder. And now, now we have, say the surviving spouse and the surviving spouse has maybe become accustomed custom to a lot of those expenses that were coming through the business. You know, maybe we were driving the vehicle that the business was paying for and maybe we enjoyed the insurance that was being paid for through the company. And maybe we enjoyed some stuff and we have a vision that the company is worth a certain dollar figure because of what we’ve been expensing through the company. But it turns out that if, when we shake the tree and figure it all out and the dust settles, that company’s really not worth what we anticipated it being worth.
Speaker 2 19:42 And so then do okay, then do I wanna sell my shares? Let’s just say I’m left with the shares and I have the opportunity to sell them. Um, but the value of the shares is not that much. I would maybe rather take the escalate that the company has been, you know, leasing for me and you know, some of the other expenses. So then I, I want to now and now I want decided I want to hold onto my shares and maybe I decided that you’re not really running the business very well and I’m now a 50% owner and I want my boat.
Speaker 1 20:10 Wow. So, uh, I think that there are a lot of things that you can, uh, play with that you can actually rake to your advantage.
Speaker 2 20:19 Yeah, absolutely. Because you can put this in writing ahead of time and then none of these things become a factor. It’s in writing the evaluation method. It is what it is. That’s, that’s the agreement. We do it in a shareholder agreement doing a buy sell agreement. Um, but we, we outlined the method ahead of time and then we have the guidance when that event actually happens.
Speaker 1 20:41 The most common way is net income and multiple of net, right? As defined in the actual buy-sell. Right. And it could be four times earnings before tax. Okay. Whatever that is. Right. Um, subject to a third party approval. Okay. So make sure that everybody keeps their hands clean. So that’s, that was number two. So the here, the six that we talking about, the business, you know about buy, sell agreements, one, they should be developed early. They should include a buy sell agreement. A, I’m sorry, a, a, a a but business valuation clause in a mechanism for it. Number three, um, they can reduce emotional impact, right? Sure. We don’t make our best decisions when we’re emotional. That’s absolutely true. Um, ask any probate attorney. Right. Um, it, when you get emotions on the way, it just, it just, it’s, it’s fertile ground for bad things to happen. Yup. Um, how do divorce lawyers handle things?
Speaker 2 21:39 I don’t know. I can’t imagine. I know several really good ones and they’re wonderful people, but I can’t imagine practicing law. Um, and in dealing with divorces, I just, I can’t, but you know, I, three, three come to mind and they’re all fantastic attorneys and they’re great people and they’re not jaded and horrible or anything like that. And they don’t take to that stuff home. No, they’re just wonderful people. But it takes, it takes the right personality.
Speaker 1 22:05 So number four, they should include ground rules. Um, and by that is, um, not only how the price is determined by how, who or who can or can be a buyer or how the business sale will be funded. Um, which is, you know, how are we going to fund this buy, sell, which we were talking about earlier. You know, life insurance is kind of a, usually one of the go to, um, um, uh, clause outlining what may trigger the sale of the company can prevent having fiduciary agents such as lenders they control in the event of a personal bankruptcy, which just happens, right? Right. Um, so number five is, uh, valuation methods matter. Okay. We, um, we talked about that and, and a little bit in number six, buy sell agreements have tax implications. There’s two things that are certain death and taxes. Well, you cannot neglect the taxes, right? And, um,
Speaker 2 22:58 we recently worked on a, um, a buy sell agreement for one of our clients in the, the shareholders. One of the shareholders wanted to retire and the other two did not want to retire. And, um, you know, we came up with a method of evaluation and, um, you know, ultimately it was even, even though that was very planned and it was well negotiated, the, the players all worked out, the terms that, you know, amongst themselves, and it was all very calm and cool and collected and, you know, it was not the source of some, some, you know, a really bad situation. It was still very emotional, really. It was very emotional. Um, when the one, um, the one who wanted to retire when he actually left, it was, it was emotional that you, I, I suppose you’re w you’re switching into a new phase in life, right? Um, and, and yes, you know, yes, the purchase price was fantastic and, and that will, you know, be, um, that will be, um, you know, something that goes into the retirement forever and it’s, it’s great. So, but even though going back to the emotion thing, even, even still, it can be very emotional, even under the best of plans.
Speaker 1 24:15 Um, how often do you find, I mean, let me ask you this, how often is this something that is brought to you as an interest of the owner before you having to kind of bring it up? Is this something that you are finding yourself more asking the business owners or are they coming to you with,
Speaker 2 24:30 rarely do they come to us with it. Rarely have they even ever thought about it. Rarely. Everybody’s so focused on start. Yeah. As this, this is a component to a healthy, healthy business. This is the component that everybody’s really good at getting it started, getting it, you know, the articles filed and all of that business. We’re really, really great at starting things. And this is a classic of any contract. We’re very good in the beginning, but are we effective at predicting all of the what ifs that could happen down the road and then providing the guidance for the what if in the contract. And that’s basically what this is. This is your providing the guidance for the rest of everybody else. The rest of the shareholders, the rest of the family, you know, whatever it may be, you’re providing the guidance for that day that either I want to get out or I’m, I’m, you know, without my choice, em out. Um, it, it’s the how we’re gonna do this piece.
Speaker 1 25:30 So before I get, you know, we’re about to go into break, so I don’t want to start any new topics, but you know, this is important. Hey, you should be listening. You’re paying attention, you know, buy, sell agreements. You know, most people don’t know about him, so you should in fact that you’re listening to our show right now tells us that you are very interested. So thank you so much. We’ll be right back with business legal talk with Leah Claudine after the break.
Speaker 0 26:06 Hey, welcome back.
Speaker 1 26:25 Thank you. Our gracious producer just read, I was actually talking already and my mic was off. So thank you very much. Our very own illustrious look, our producer, um, a what? Come back a beautiful Saturday. Lots of going on by, we were talking about bicycle agreements here, the studio and is, it
Speaker 2 26:43 could be very fun. Yeah, absolutely. No buy, buy, sell agreements are actually a lot easier to contemplate and, and to decide on and work through than an estate plan. And a lot of folks avoid the whole concept of estate planning because you’re really planning for, you know, after you die and, um, buy, sell agreements are not necessarily for protecting you or protecting your assets if you die. But it works in that way as well. So they’re, they’re very good, but it’s really a great exit strategy plan. This is how, how you want to kinda think about it, how, how are, how am I going to leave this business that I have put 20 or 30 years of my life in to carry cared for it like a child. And, um, you know, just sacrifice so much for it. You don’t want to just walk away and have a disintegrate into nothing.
Speaker 2 27:33 So we, you know, back to the buy sell agreements, there are several different types that you can do. You can have a buy sell agreement, which is very common just between say two owners or maybe two, two businesses that are not, um, co owned. For example, it would be like me having another law firm, uh, create an agreement to purchase my business. Um, should something happen to me. And those are typically referred to as cross purchase agreements between a couple of people. Um, then we have the stock redemption agreement and lease enlightened me stock redemption agreement is, um, says that I can sell my shares back to the corporation because the corporation is a separate entity and it can own the shares as well. So for example, if there’s, um, a hundred shares and there’s two shareholders and let’s say on a personal level, I would need to raise a little bit of capital, which I know something we’ve talked about.
Speaker 2 28:29 I can, we can have an agreement in our shareholder agreement that allows me to share, or excuse me, sell my shares back to the corporation. Okay. And then the corporation owns them. And then if the corporation ever needs to raise capital, the corporation then has shares that it can sell. Right now, of course, we’d be bringing in another owner. Right. You know, so that brings on a whole nother conversation. Um, but then we can also have the combination, um, a combination agreement of the structure gives the owners the option to do either a, uh, either a direct buy, sell with another owner or to sell it back to the corporation. Um, it will did determine the right of first right of refusal. And so essentially that’s the one thing that we have to iron out. So if I have a combination agreement that says I can either make the choice to sell shares to the other shareholders that are existing within the business or I can sell it to outside, um, or I can sell it back to the corporation, typically the other shareholders within the corporation want first right of refusal, which means that I get the first choice to say, yes, I want it and only if I reject it, does it get sold back to the corporation.
Speaker 2 29:44 The other thing to be very, very careful of, and I mentioned it a couple of times, is um, you know, selling your, creating a buy sell agreement with somebody outside of your corporation. That’s great if you’re a sole sole shareholder, if you’re in a partnership, that is something you need to be very, very careful with. Um, and both partners really need to be on board with the same idea. So there’s, say for example, there’s two partners in my law firm and we decide together that if something were to happen to me or my other shareholder, we will sell to, you know, a third party from outside of us. Um, it’s doable. Again, in the world of contracts, anything’s doable. We can contract for anything. We, there’s, there’s literally no limits other than just a very few that would make a contract void. But by and large, we can agree to it to do whatever we want. So it’s always doable, but you want to be very, very careful if you are creating a situation where there will be an automatic new owner or new partner. Okay, so let me stop you right there. So
Speaker 1 30:53 I’ve realized that by doing this show that the average listener is not going to sit here the entire hour, right there. Come in and go. So if you’re just an into this show, we’ve been talking about business, a buy sell agreements between business owners. So here’s the obvious question.
Speaker 2 31:07 Who went, when does a business need a buy sell agreement from the day you open? And in my opinion it’s, it should be part of the, the comprehensive, um, starting of a business when we do the business plan, when we filed the articles of incorporation, when we draft the bylaws, we should be thinking about this as well. One of the things that impressed me the most when we first met that
Speaker 1 31:31 you are very proactive and the way you work with your clients. So from cradle to grave, whatever, but, but really you get with your clients once a year and you actually look at, make sure that they’re fully protected all the legal documents that are in place for the business. And so you’re, this is something that you’re constantly bringing up.
Speaker 2 31:49 We do, we do. And we do try to have at least one sit down a year with our clients where we discuss just the corporation. There are some corporations, um, some businesses that are looking at and modifying and dealing with corporate matters, um, throughout the year because of their size and so forth. Or they have people coming and going. Um, and so we have to adjust the, the bylaws or we have to adjust shareholder agreements and things like that. Most of the time I find that clients, once they set up the entity and it gets the articles of incorporation or F are filed or you know, the partnership is created. Once we do that, we go on about whatever the business does and we’ve don’t circle back around to deal with corporate matters. And it’s critical. It’s critical that we do so is one of the corporate matters that is just part of the whole corporate housekeeping bucket.
Speaker 2 32:46 Okay. So we’re talking to probably to a new audience that hasn’t heard some of these things before. Hey, let me ask you this. This is not just for corporations. I mean, I’m just, I don’t mean to interrupt, but just, just in the, in the effort to, I, I don’t want people listening to think that this is just for corporations. If you’re in a partnership, this applies to you. If you’re in a limited partnership, if you’re in an LLC, if you’re in BC, a PC, anything other than a sole proprietor, right? This applies to you. Um, kin, what happens if a company needs to, uh, can’t afford to buy one of the owners out? Well, and that’s where life insurance is, is usually the GoTo. Um, we can also sell assets, you know, so for example, if, if, if the company owns property, let’s say maybe it owns the building itself.
Speaker 2 33:40 Um, and that is a real issue. So when we are looking at it, it’s not just the logistics of who would buy who for how much it’s coming from. And we’re back to raising capital again, that, that place again. And so life insurance is oftentimes the vehicle. It’s a very easy vehicle, particularly if the shareholders or the partners are younger. Um, you can buy life insurance on each other and you can start off. Obviously the younger you are, the, the higher the, the bill is. Um, and you can have that life insurance policy split. And I mentioned that a little earlier. It’s very easy to have the life insurance split and we recommend it actually. Um, so that part of it goes to whoever would be the owner. But the life insurance only comes into play in the event that the shareholder or the partner dies. Hmm.
Speaker 2 34:43 How do we do it? If the person says, I just want to leave the corporation, I don’t want to do this business anymore and I have 50 shares and or I have 150 shares or whatever and I want to sell them. If we haven’t dealt with it in the bylaws or in the shareholder agreement, those shares are your property, right? You can go sell them, you can put them out on the market, you can find a buyer for them. And that now brings on a whole nother set of circumstances because now do the remaining shareholders or does the remaining partner want to have a voice is into as to who you, who do you sell them to? Who are, you know, you’re selling your shares, you’re walking away. That’s great, but now, now I’m going to be in business with somebody I don’t even know.
Speaker 2 35:29 Um, and so this is where we deal with it at the inception part. And if we haven’t dealt with it at the inception part, and let’s just say we’re 10 years into this business, we just, we can go back and modify it, the shareholder agreement or the bylaws to it to incorporate it. But, um, we may have to take out a loan. I’ve worked with businesses where the shareholder took out a loan or we did a promissory note. We’ve done promissory notes where, where the person, the remaining shareholders drafted or executed a promissory note that said, I will pay X amount of dollars over the course of, you know, X amount of settlement basically. And so, and, and so basically that was going to come. That’s going to come out of the profit of, of the corporation.
Speaker 1 36:17 That’s very good. Does, do you address, um, capital calls within the buy sell agreement or did we have that in the bylaws?
Speaker 2 36:27 We will typically have it in a buy sell.
Speaker 1 36:30 So company needs to raise the mic, give you throw a hypothetical example. We, the company needs to raise capital to the tune of 100,000 and there is three shareholders and say they’re all 33 33 and 33 and a third, whatever that it works out to. Maybe that’s not a good example, but there’s two 50 50 and each one is to raise 50,000 so a hundred thousand what happens if one comes up with the money and the other one does it?
Speaker 2 36:55 That’s going to be in your bicep or in your bylaws or your shareholder agreement and you know that there is no quick answer. There’s no just one. One way answered that. Again, back to the idea contract and back to the idea of trying to forecast all of the what ifs, right? And that’s a great what F so then the question would be back to the, the remaining shareholders. So what do we do? Do we liquidate something? Does a corporation, does the core, does a corporation have money that it can lend? But if you’re raising capital, presumably no, the answer is no. So then do the other ones take over more shares?
Speaker 1 37:33 People underestimate, right? The power of that equity, the power of those shares that they hold,
Speaker 2 37:40 it’s the most expensive thing that you’ll sell,
Speaker 1 37:43 right? I think people under, they throw the word equity around like it’s, it’s, it’s just um, uh, fashionable, right? Right. And without really fully understanding. And that the reason why we’re talking about this is you shoot seriously as a business owner, think carefully about when to part with equity. And I think there are times when it’s absolutely necessary. And um, you know, I always say, you know, cause I have helped in a continued am actually actively helping companies raise capital for different, not all the, all the money for your business is going to come from a loan or the SBA. There are times when you have to take an opportunity to market that the banks are not going to want to give you, uh, eh, the, the, the, and then I’m going to give you any capital. You don’t qualify for it. Your ratios out on the line, you know, your current ratio, your current liabilities. It’s not in line with the, you know, the current assets and et cetera. So you’ve got to go outside to private investors and they’re gonna want equity and that equity is very expensive, but they’ll argue, okay, well do you rather have 100% of a company that is one of zero or 25% of a $10 million company,
Speaker 1 38:49 right? Some people will argue, Hey, I want to have a smaller fraction of a more successful company, but that comes with rules, right? And rules of engagement, right? Right. And the sophisticated investors are going to know those rules and you need to be equipped and I guarantee you they’re going to have some buy, sell up, very strong buy, sell agreement. Right, right.
Speaker 2 39:10 Absolutely. And one of the, one of the advantages of working with somebody who does this on a regular basis is they have experienced the pitfalls. So in my, in my world, I see on a daily basis that which most people see once or maybe twice in their career
Speaker 1 39:29 said really, really, really good. But I want you to hold onto that thought because we’re going to come back to it high. You being, um, I’ve been told that we need to go to a break. Why, why has that wasn’t necessary? So thank you so much for listening. Stay tuned. We’ll be right back. You’re listening to business and legal talk with Liam, Claudine
Speaker 0 39:44 .
Speaker 1 40:09 Hey, welcome back. Uh, this is, uh, what, what are we, anyway, this is a legal talk with the equity and it’s been a long week. It has been a long week and it’s only Saturday. I know I’m out of gas already. This is actually the end of our week. Well, we’re still working well working. We’re having fun. We’re doing what we do, but we also be unreal. Right? And what you’ll get from us is being transparent, but Hey, so we, we paused and we were talking about or have been, uh, having fun with buy, sell agreements in there is just a lot of questions. And you had a, um, uh, well the importance of equity, that’s what we were talking about. Yes. And uh, where do we want to go with this? I mean, w which way do you want to go?
Speaker 2 40:49 Well, you know, when we talk about, um, buy, sell agreements and using life insurance and stuff, I think everybody, if, if people right now, if you’re out there listening and you’re thinking to yourself, wow, this is maybe something I can tackle this year, I should start really making a plan for, you know, the sales of the business, if, if I should die or what, you know, rather than just letting it go into, you know, thin air and disintegrate. Um, know that one part of the puzzle is to also cultivate somebody within the business who can take over your role, um, and who can perform the tasks that you perform. Um, and that’s something that’s really, really important. And a lot of times I see business owners cultivating their purchaser and maybe that purchaser is going to be somebody who is not a shareholder of the business or not your current partner, but it’s somebody who’s been faithfully working in the business, enjoys the business, knows the business, and is agreeable to step into that role.
Speaker 2 41:49 Should something happen to you. Um, again, we can go back to life insurance to fund it if that’s possible. If not, perhaps the person that you’re cultivating could get a loan, would be willing to sign a promissory note and take proceeds out of the business each year to pay on the promissory note. Um, there are tax implications because when you use life insurance, life insurance typically is not taxed, right? But there are top tax implications when you start to do buy, sell agreements. So that is something that we leave for the CPA or the tax person and we want to always, always, always loop them in the conversation. Correct. When we, when we say, okay, this is what we’re thinking, tell me what the tax implications are. That’s how we approach it. Because I do absolutely zero tax conversations at all.
Speaker 1 42:44 And you know, for the record I am, there’s so much to keep up. It’s a full time job to keep up with the tech changes in the tax code. As you know, there was this, the biggest sweeping change of the tax code in the last 20 years has been last year, 2018 and most people don’t even barely understand it far be it from me to it, you know, talk about that. That’s not my area of expertise. I care more about helping the business be profitable and throughout the year in the managerial accounting as a CFO. But with that said, I think the operative word is income and what is determined as income because it at all, all roads lead back to your 10 40 right? So LLCs, a PCs, S Corps that that’ll pass through entities. So the income will be swept from in a form of a K one right? Right. Get your w two income if you, if you are, if you’re, if you have a salary and then you add that to your, and then you get your K one right. Coming through in what is determined income. And I don’t know whether I’m just are, I mean making the arguments. So if I, if my spouse got a windfall from a life benefit, does that be considered income?
Speaker 2 43:57 I, you definitely, I reserve that for the, for the tax person and perhaps there’s the tax person out there that that is just itching to answer that question. Give us a
Speaker 1 44:06 and we need to bring probably a as a great guest to have, right? Somebody who actually has all these intricacies on working with bigger companies on because there what is a taxable event, right? But it’s good problem to have if you’re old is money coming in, right? The whole problem with taxes is they actually have income. So it’s not a problem to pay taxes. If you’re making money. I’d rather you be paying taxes. They’re not making any money at all and you have zero tax liability, but you don’t gotta be going out business, which would you rather have? Um, fun times. Well good. This is good stuff. This is good stuff. So I have this question for you. You know, I’m not sure if you know bankruptcy, can a co owners personal bankruptcy affect the,
Speaker 2 44:44 absolutely. Because your, your bankruptcy is going to be looking at all of your assets and what you own. If you own shares, if you own shares and that’s a very good question and that that is something that bankruptcy attorneys are going to going to be weighing in on
Speaker 1 45:02 but you may not be able to because there’s a threshold that you have to have of assets. If you have way more assets and they say your say your shares are equal to or above the thresh, although while you’re allow illegally allowable, you may not be able to file right for right bankruptcy.
Speaker 2 45:19 It’s, it’s definitely, it’s definitely an effect and that’s one of the things that we, we, that’s when the things that you definitely are dealing with at the last minute so to speak rather than the plan ahead stuff, which is more of what we deal with. But definitely um, if you own shares of a, of a company and you’re personally trying to file bankruptcy, you know, that’s where you want to make sure that you’ve got a bankruptcy attorney on hand that that understands how to incorporate that because the shares are the shares, they have a value just as we’ve talked about, you know, valuation. It is what it is there they are there. So it’s like a vehicle. So you have a vehicle that could be worth 20,000 or you can have a vehicle that’s worth $200 if the shares are worth the shares. And there’s gonna be questions by the bankruptcy trustee if as to what’s the value, how are we going to evaluate them, uh, evaluate the shares and so forth.
Speaker 1 46:17 Even though this can be increasingly complex. Yes. And the bigger the business gets. So I encourage you, if you’re growing a business, it will be foolish to go at it without the help of the professionals in the areas of expertise. I always say, do what you do best and bring professionals for the rest. And I stand by that because there’s no possible way that if you’re running a any type of business, you’re going to know every area of the business, right? And even you were expert in law, you’d realize that there are some areas that are the business that you don’t really understand, right? So for this matters of buy, sell agreements and the tax implications there off, you’ve got to have professionals in different experts, not just lawyers, but lawyers with expertise in the subject matter. Right.
Speaker 2 47:00 And that’s one of the things about our industry that’s really important for people to understand is that attorneys, we typically stay in a certain lane depending on where our area of expertise is or area of experience. Um, and so our industry is broken into so many smaller areas of expertise. So there are people who literally do nothing but, um, evaluations of, um, Oh, I’m in the retirement plans. So when were like divorces, um, when you go through a divorce and let’s say has been a wife have been contributing, you know, uh, husband’s been contributing to his retirement plan, you know, for the first 10 years of the marriage. And then, then they get divorced and the wife is entitled to her community share portion of it, but her community share portion doesn’t come until retirement age. Meanwhile, that money sits there and grows. But at the end, it’s not worth, you know, it’s not a clear cut path to what, what her portion would have been worth on that day.
Speaker 2 48:05 That of divorce versus what is her portion worth on, you know, on the day, uh, at age 65 retirement. So I mean, that’s kind of a long example, but our industry is broken up into, um, very small areas. I mean, there are, there are labor employment attorneys who literally focus on about 15 or 20 labor codes. That’s it. And that’s their area of expertise. So it’s absolutely important. Um, you know, what we do is we do general business upkeep, general business keeping business bookkeeping, not bookkeeping in the term of, you know, numbers, but keeping, yeah, the, the corporate housekeeping. Um, there’s so many keepings I know, right? So, all right. Anyways, so let’s bring it home. So we’re talking about sustainable and profitable. So definitely today was about being sustainable. Yes. Um, and I know the real cases in which you’re making me think about, do some of my clients have by sale agreements in place.
Speaker 2 49:09 Most of the business that I work with are multiple owners that are non-related, some of our family, but even I think it doesn’t discriminate. So you have a husband and wife or you have a brother and sister even more than ever. Right? Right. More of a reason to have a buy sell agreement because good things get emotional. I have one client that I work with who will obviously renamed remain nameless large company here in the Valley, large company. Husband and wife started it and had been in the business for 20 plus years and they got divorced, but they stayed in the business because those shares were a value. It was their income, it was their personal income together. They worked together, both both remarried and still remain partners and still remain partners. Oh my goodness. And the business is absolutely thriving. It’s, it’s a fantastic business here in the central Valley and you know, that is really a Testament to the value of equity and what it can really encourage us to do to be reasonable, be sane.
Speaker 2 50:14 Let’s not blow up the business just because we decided we don’t want to, you know, stay, remained married, but we each have a job in the business and we have a responsibility to the business and we continue to work for the business. Wow. And it is possible. But that was because somebody stopped and thought about and said, do they have a bicycle? Um, no, I, I’m not sure that they did in the very beginning, but at the point that they got to the fork in the road, they made a conscientious decision of what we’re going to do. Um, and that, that was the decision that they made.
Speaker 1 50:48 That’s fascinating. So we have, um, we have been listening and I’ve been talking to people that were being, um, communicating, uh, we’re thinking of great show topics to cover the next, you know, end guests over the next few weeks and months. Um, we really love doing this show. It, it speaks to something that we’re passionate. I think you were both you and me both love to teach and give the knowledge that we have that we have earned, uh, over many years and we want to put that knowledge to use. And you know, we both volunteer different organizations, uh, and we give away our time. And if you take one thing away from what we talked about, um, particularly in buy, sell is you gotta just go back, press and reset, go back and look at your legal, if you have any, if you have a partner, you better have a buy sell agreement.
Speaker 2 51:39 Absolutely. Absolutely. And I’ll tell you, it’s, it’s something that should be revisited over years. So if you, let’s say your corporation or your business, you know, was created 15 years ago and things have been going, wonderful, things may have changed. Uh, your evaluations obviously should’ve changed. Hopefully they, they have changed and we may need to readdress life insurance policy limits and we may need to just readdress how the buy sell agreement is drafted. Um, over time. Just like anything else, we draft things differently now than we did draft them maybe 15, 20 years ago. Uh, language is a little bit different. Different styles, different, different way of going about it. Um, I read living trusts that were drafted 25 years ago and it’s completely, it’s just a different, the elements are still the same, but the way we went about drafting it, um, whereas now I find they’re a lot cleaner language, a lot more straight forward language. So, you know, those are things that you want to look at. Your buy, sell agreement, shareholder agreements, those things should be addressed.
Speaker 1 52:42 Well, thank you Claudine. Great, great stuff today. I thank you for, you know, your, you’ve always given us, you know, the actionable in great expertise. Thank you everyone for tuning into today’s show. It was a pleasure having you and thank you so much for always turning into business and legal talk with your Claudine. Have a great weekend everybody. Thank you. .