Ownership Protection: The Buy-Sell Agreement

No matter how a business is structured, it requires a mechanism to transfer the equity or control of the business in the event that the principle owner or manager is unable to continue.  This also applies to the members of the board, and senior management.  This is why a buy-sell agreement is necessary.

A buy-sell agreement is a legal contract that outlines the details of how the ownership of a business will be managed upon the death or serious disablement of a partner or shareholder  It provides clarity and certainty regarding the future ownership and operation of the business.

Ownership protection is important for several reasons.  The control and future ownership of a business may have to be reconsidered if one of the partners or shareholders passes away or be unable to continue due to disability or critical illness.  This prevent situations where funds may not be available, the value of business under contention, and beneficiaries may be disadvantaged.  For example, banks may cease to provide credit, or leverage, and give a notice of assessment.  Creditors may call in debt should they be unconvinced of the business as a going concern.  Ownership protection through buy-sell agreement will ensure existing shareholders receive a fair share of the company.  An appropriately structured series of life insurance policies mitigate risk, and provide surviving shareholders some funds to compensate the estate of the deceased without compromising shareholder, and retain control of the business.  The payout is also important because there is a cost for the executive search for a suitable replacement, and this would take time.

The process of using insurance for buy-sell agreements is not complicated.  A specialist lawyer can prepare the buy-sell agreement after the shareholders have discussed and agreed accordingly.  It is important that the agreement is reviewed annually to ensure all shareholders are still in agreement with the terms, and they still accurately reflect the current needs and value of the business.

 

Quora Answer: Should I Offer Board Positions to Large Investors?

The following is my answer to a Quora question: “I am planning a seed funding round in the near future.  Should I offer board member positions to large investors?”

An investor is not automatically qualified to manage a business.  There are three kinds of people required to make a business work: the one with the knowledge of the product or service, the one with the time or opportunity to manage the business, and the one with the funds.  Often, they are not all the same person.

Offering someone a position on the board means putting them in a position where they have some say in the running of the business, whether in daily management, or strategic direction.  Just because someone is able to put in large sums of money, does not mean he knows how to manage and grow the business.  If he could, he would not need to invest in your company.

Positions on the board are offered to people who have strategic value.  They may have access to certain markets; they may be there for optics, and prestige; they may be there because they have relevant experience.  They are not there because they put in money, or they are friends of yours.

Sometimes, large investors, particularly institutional investors, or professional investors, may negotiate for a representative on the board.  This may be a means for them to ensure that funds are spent in the growth of the business, and not excessively taken out as compensation to the founders.  This is especially so if the founders have a viable product or idea, but no management or financial experience.  In such a case, it is not a vote of confidence, and they may eventually take over the company and ease the misperforming founders out of executive management.

In such a case, it is not simply a case of offering investors a seat on the board, but putting in place a share structure that allows you to retain control of the business.  Both sides negotiate, and come to some compromise where their interests are largely addressed.

Quora Answer: Besides the Way They are Funded, How Do Startups & Small Businesses Differ?

The following is my answer to a Quora question: “Besides the way they are funded, how do startups and small businesses differ?”

The primary intent of a start-up is the exit.  It is about building a foundation that can be scaled up, to bring in more funds to generate more revenue.  A start-up, as the name suggests, is the beginning of building a vehicle to carry out a specific business.  At the end of it, the founders have either sold their stake and moved on, or they have taken the company public, which means they are no longer sole owners.

A small business does not have such ambitions.  The intent of the owner is to generate revenue, so that the business owner can take profit out.  It may or may not be a company.  A small business does not have the express intent of seeking funding to scale up the business.  Often, the nature of the business process precludes any such scaling up.

Quora Answer: What are Some Pros & Cons of a Sole Proprietorship versus a Limited Liability Company, in Singapore?

The following is my answer to a Quora question: “What are some pros and cons of a sole proprietorship versus a limited liability company, in Singapore?”

A sole proprietorship is a lot easier to run than a limited liability company.  That is the only so-called advantage.  There are several reasons to start a limited liability company.  These reasons are worth it, despite the extra paperwork required.  One reasons is to create a structure where there is more than one person, with some being shareholders, and others being directors.  The legal relationship is quantified, and therefore, easily administered.  A company allows you to incorporate capital injection and drawings in a transparent manner.  A company mitigates your tax liability, lowering your tax bill because you are taxed after expenses, not on gross income.  With a good accounting system, you are able to expense out a lot of activities.

Despite what many believe, a limited liability concern does not always protect your assets in the event of a bankruptcy petition.  That is a myth.  This may be true for a company loan from an individual or another company.  When a company takes a loan from the bank, the documentation clearly states that the not only is the company liable, but the directors are personally liable as well.  This means when you are sued by the bank for a default, and the company is broke, the bank will go after the directors.  The bank always starts with the director with the most assets, and he may not even be an executive director, or the one who signed the loan.

A company does protect you from litigation pertaining to non-performance of a contract, or non-payment of services and goods.  In such a case, the company is liable, not the directors.  This is useful, especially in litigious industries such as shipping.  NOL, before they were bought out by CMG, structured their fleet management such that every single vessel was owned by a company.  For example, we take the old NOL Sardonyx.  The vessel owner was Sardonyx Pte. Ltd.  Sardonyx Pte. Ltd. would be a wholly owned subsidiary of NOL.  The vessel would be managed by Neptune Shipmanagement Services Pte. Ltd.  This spread the potential liabilities around.

In the event that NOL Sardonyx collided with another vessel due to negligence, for example, and sank, there would be a massive bill.  First, would be the bill for the loss of cargo and crew. Then would be the loss of vessel itself.  All of this would be taken care of by insurance, but there would not impact on other vessels in the fleet since this would be a separate company legally.  So, there is no reason that the reinsurer can raise premiums on the remaining vessels of the fleet.

Second, there would be the bill for pollution, under MARPOL.  There might be fines and civil penalties under SOLAS.  If this happened in port waters, or near a tourist resort, there will be civil suits for loss of earnings.  Perhaps the estate of the officer might sue for wrongful death.  In the face of adverse judgement, Sardonyx Pte. Ltd. would declare bankruptcy, and there is no award to be claimed.

NOL, the parent company, is shielded from further legal and financial action because they are a separate company, even though they are the sole owners.  This also means that any financial impact on the subsidiary does not affect the leveraging of the parent company negatively, such as a major fall in share price.

There are a lot of uses for limited liability concerns.  As the name suggests, liability is limited to the capitalisation of the company.  A $100,000 paid up capital concern can only be sued to $100,000.

Quora Answer: Is It Worth Buying Insurance in Singapore if I Plan to Migrate?

The following is my answer to a Quora question: “Is it worth buying an insurance policy in Singapore if I plan to migrate?”

It depends on what type of insurance exactly.  There is no point getting any sort of hospitalisation plan since you are paying for benefits that you can never use due to the legal limitations of the Shield plans.  There is a possibility of a group health coverage owned by a company you own.  The advantage is that the coverage is international, and after a year, pre-existing conditions are covered.  But again, this is relative to what you can get wherever you are going.

A lot of non-Singaporeans get investment-linked insurance plans because they provide a good return of around 5.5%, when managed properly.  They use these plans to park liquid funds to avoid taxation.  It is perfectly legal, albeit a bit on the grey area.

Non-residents also get whole life plans that have critical illness coverage.  The coverage is international, which means claim is not a concern.  They structure these plans to create an immediate estate.  Often, they assign it to a trust.  Such plans have a surrender value, making them financial instruments in their own right.

For those who are non-residents, but are directors of companies registered in Singapore, term plans are used as a hedge against the uncertainties of business succession at an executive level.  They then perform an absolute assignment of the plans to a company, and put it as a benefit to the director on the books.

Quora Answer: How is Building a Business to be Acquired Different from Building a Business to Own & Operate?

The following is my answer to a Quora question: “How does building a business, with the goal of being acquired, differ from building a business you intend to own and operate?”

The first goal is always to build a viable business first.  Your foundations - financial, management system and customer base – have to be strong first.  The next stage is to focus on one of three main types of market leadership: best customer intimacy, lowest overall cost, or best innovation.

Once all that is addressed, then comes the decision to have an exit strategy, or to continue.  These two goals may not necessarily be mutually exclusive.  If your exit strategy is to sell the business, you need to make sure your balance sheet and market potential is attractive to an external investor. Investors are paying for your potential and where they see you.  Thus, you position your company in that direction.

For example, I am a director of a company that will eventually be acquired.  What we did was build up our position in a sector where we knew a specific company was pushing into.  As a smaller entity with greater market intimacy, we leveraged on that to build a very specific market share in a strategic market, and waited.  It is the equivalent of staking a claim with the intent to sell to the most attractive bidder.

On the other hand, I am also director of a company I have absolutely no intention of selling.  That company is my vehicle for specific projects. In such a case, we focus on slower, more organic growth.  The intent is to grow the business quietly, without attracting attention. In that sense, it is the opposite of the previous company.  We spend time grooming a management team, and are preparing a succession plan.  The exit strategy for this company could be an IPO, although that is unlikely; or taking a stake in a downline entity.

Quora Answer: Can Other Shareholders or Directors Vote the Founder of a Private Limited Company Out?

The following is my answer to a Quora question: “I am a shareholder, and founder, of a private limited company in Singapore.  Do the other shareholders, or directors, in the company have the right to kick, or vote me out of the team?” 

By removing you from the “team”, I am assuming the management team.  They cannot remove you as a shareholder unless they buy out your shares, and they cannot force the issue.  Even as a minority shareholder, you have rights.  As for being removed from management, if there is enough support from the shareholders, they can do that.  It requires a majority vote, and a resolution.  This is a drastic measure, and people do not engage in this sort of behaviour unless there are deemed to be major lapses in management, huge differences between the majority shareholder and the management team, or something equally dramatic. 

Founders of start-ups normally issue themselves shares with special voting rights, which preclude such action.  Class shares may have ten times, or even a hundred times the voting rights of ordinary shares.  This allows them to sell large stakes of the company to external investors and funders, but still allow them control of the board.  If you do not possess such shares, then it is a matter of a majority vote, as stipulated by the memorandum and articles of incorporation.

Yahoo! & the Art of Failing Spectacularly

Yahoo! was originally founded, in 1994, by Jerry Yang Chih Yuan, and David Robert Filo.  It was an early mover in the early internet era of the 1990s, and its search engine was ubiquitous.  The company was formally incorporated on the 02^nd March 1995.

From being one of the largest internet companies, Yahoo! declined, beginning in the late 2000s.  Yahoo! was acquired by Verizon Communications, in 2017, for US$4.48 billion.  This acquisition excluded its stakes in Alibaba Group and Yahoo! Japan.  These were transferred to Yahoo!’s successor company, Altaba.  In business, the story of Yahoo! is an interesting case study, and an Exhibit B, on how to ruin a promising business.  It is a tale of bad management, spurned opportunities, and believing too much in their own marketing.

There are many reasons why Yahoo! declined rapidly, but we can look at several events that best encapsulate why.  Yahoo! was in a position where it could have acquired what became Google, Facebook, YouTube, eBay, and Snapchat, amongst many others.  It had all the advantages.  That behemoth would have been worth hundreds of billions of dollars today, and control the market.

In 1998, Lawrence Edward Page and Sergey Mikhaylovich Brin, two PhD students from Stanford University, California, offered to sell their start-up to Yahoo! for US$1 million.  Yahoo! wanted people to spend more time on its own platform, which offered more advertising opportunities for them.  This contrasted with the PageRank system, which directed people to the most relevant website based on its links, and connections.  Accordingly, Yahoo! declined.  Prior to that, Alta Vista had declined the same offer.  That company was eventually incorporated as Google, on the 04^th September 1998.

However, that ship had not truly sailed.  In 2002, Terence Steven Semel, the CEO of Yahoo!, began negotiations to buy over Google.  In the initial round, it is aid that Yahoo! proposed buying Google for US$1 billion.  Google’s founders counteroffered with US$3 billion.  When Semel came back with a US$3 billion offer, Page and Brin wanted US$5 billion.  Yahoo! declined.  Today, Google is worth well over US$500 billion, with an annual operating revenue of almost US$70 billion.

In 2006, Yahoo! began negotiations to acquire Facebook.  Semel had up to US$1.2 billion to play with.  Mark Elliot Zuckerberg wanted US$1 billion, which was within that mandate.  However, Semel tried to give a lowball offer of US$850 million.  Zuckerberg stopped negotiations, and that opportunity was lost.  Today, Facebook is worth over US$80 billion.  Lessons were not learned.

In 2008, Microsoft gave an unsolicited offer of US$44.6 billion for the entirety of Yahoo!  This was a premium of 62% over Yahoo!’s closing price, an about US$31 per share.  Microsoft was looking at expanding into the online advertising market.  Yahoo! turned down the offer.  In the end, it still ceded its search business, at no gain to itself, and gave it up to Microsoft’s Bing.

Jeremy Ring, a Yahoo! sales executive from 1996 to 2001, and currently a politician, wrote “We Were Yahoo!” which gave an insight on the boardroom failures that lead to this.  In an interview, when asked to sum up the Yahoo! saga, he said, “Yahoo! owned the Earth, but never looked at the sky.”

Quora Answer: Is the Book, “Rich Dad, Poor Dad”, a Worthwhile Book for Investing?

The following is my answer to a Quora question: “Is the book, ‘Rich Dad, Poor Dad’, a worthwhile book for investing?”

As a finance professional, I say this book of full of stupid advice.  The only thing you can take from Robert Toru Kiyosaki is that one of the best ways to make money is to write self-help books, and he did.  He sold tens of millions of copies of the entire series giving bad advice on wealth.

In his book, Kiyosaki also wrote that multi-level marketing is an excellent way to build wealth.  He then set up the “Rich Dad, Poor Dad” product line as just such an MLM.  This is entirely self-serving, and the only person who got rich was Kiyosaki himself.

The books then runs through a litany of nonsense.  For example, he claims that formal education is a waste of money.  This makes sense because only the semi-educated would fall for his con.  He also claims that mutual funds are for “losers”, when they are actually one of the better ways of generating wealth – Warren Edward Buffet did not become one of the wealthiest men in the world selling self-help books.  All his “advice” on derivatives are guaranteed to lose you money since he does not understand how futures contracts work.

Despite all this, the one thing that totally discredits him is the corporate bankruptcy of Rich Global, LLC in 2013.  The company lost a court case on a royalty dispute and was supposed to pay the Learning Annex US$24 million.  For a business with a supposed revenue of US$400 million, this should be a pittance.  When he filed for bankruptcy, it became obvious that he did not even follow the reasonable advice he espoused in his books.  When your entire branding is based on prudent financial management and wealth acquisition, this totally destroyed his credibility.

How a Gangster Rapper Hustled a Corporation & Became a Billionaire

Beats Electronics LLC is the subsidiary of Apple Inc. that produces audio products.  The company was founded as Beats by Dr. Dre was formally established as a company in 2006.  It was founded by well-known music producer and rapper, Dr. Dre and former Interscope Geffen A&M Records chairman, James Iovine.  Beats Electronics LLC has a US market share of at least 60% for headphones priced over US$100., and an estimated market valuation of US$1.5 billion.

The story of how Beats by Dr. Dre became Beats Electronics LLC is the story of how a gangster from the streets outmanoeuvred two major corporations for market domination.  In short, Dre hustled and succeeded.

The official story on Wikipedia and the company website is that Dr. Dre and Jimmy Iovine thought Apple’s earbuds were inadequate.  They said that if their music was going to be pirated, then people should, at least, listen to it with the best equipment possible.  Allegedly, Dre said to Iovine, “Man, it’s one thing that people steal my music; it’s another thing to destroy the feeling of what I’ve worked on.”  This is the publicity spiel.

The story of the rise of Beats Electronics LLC is the story of the demise of Monster Cable.  Monster Cable was founded by Noel Lee in the late 1970s, and made its name in overpriced cables and litigation.  The company was a corporate bully.  Monster sued everybody that had “Monster” in its name.  According to the US Patent and Trademark Office and court records, Monster Cable has gone after a mini-golf course, a thrift shop, a used clothes shop, Walt Disney Co. and Pixar Animation for their film, “Monsters, Inc.,” Bally Gaming International Inc. for its Monster Slots, Hansen Beverage Co. for a Monster Energy drink and even the Chicago Bears, whose nickname is “Monsters of the Midway.”  This aggressive legal strategy did not make them any friends.  And people who have no friends, no matter how big, are vulnerable.

Monster Cable did the actual engineering of the headphones for Beats by Dr. Dre.  Monster Cable had built its market domination more on marketing than product quality.  Its market share was built on the uncertain foundations of brand familiarity.

As an extension of their aggressive litigation strategy, Monster Cable was notorious for claiming patents on basic technological concepts.  An example can be seen in the response from Blue Jeans Cable, from the 28^th March 2008: “Monster Cable recently wrote to us claiming that we had infringed various design patents and trademarks owned by it or by its intellectual property holding company in Bermuda, Monster Cable International, Ltd.  We reviewed the patent and trademark filings submitted by Monster Cable, and found that Monster’s claims were completely frivolous - so frivolous, in fact, that there was something amusingly appropriate about the fact that Monster's letter had arrived in our mailbox on April Fools’ Day.”

In all this, Monster Cable’s products were notoriously no better at doing their jobs than coat hangers, as can be found in this example: Audiophile Deathmatch: Monster Cables vs. a Coat Hanger.  And when there are articles like these, all the litigation in the world is not going to protect the brand.  The cables were copper wires sheathed in plastic.  There is only so much that can be done to make them work better.  The best marketing does not change basic physics.  But that marketing cost was passed on to the consumer, raising the price of a mediocre product exorbitantly.

Thus, Monster Cables had painted themselves into a corner and needed Beats by Dr. Dre more than the latter needed it.  Monster Cables thought that the hype of a celebrity endorsement and the promise of further celebrity endorsements by contacts in the entertainment industry would overcome the negative image it was beginning to develop.  Unfortunately for Monster Cables, Dre and Iovine know exactly who held the cards here.  I would not be surprised that these two had identified this weakness and played Monster Cables from the beginning.

The Beats headphones were terrible.  To quote a passage in How Dr. Dre’s Headphones Company Became a Billion-Dollar Business, Burt Helm wrote that Iovine said, “We got dumped on by audiophiles on Day One.”  He continued, “We wanted to recreate that excitement of being in the studio.  That’s why people listen.”

The story here is a that Beats headphones “were not tuned evenly, like the usual high-end headphones.  They were tuned to make the music sound more dramatic.”  “More dramatic” is an euphemism for “they cranked up the bass.”

It was a rubbish product, but consumers fell for the hype, and from its launch in 2008, the company grew exponentially.  In 2010, Taiwanese consumer electronics manufacturer, HTC, bought out Beats by Dr. Dre for USS309 million.  This buy out is noteworthy because, under its terms, Dre and Iovine eventually actually gained executive control of the company from Monster Cables: After HTC Sale, Dr. Dre & Jimmy Iovine Gain Control of Beats Headphones.

By the 23^rd July 2012, HTC sold half its position to Dre and Iovine, allowing them to control 75% of Beats by Dr. Dre, leaving HTC with the remaining 25%.  Not only that, HTC revealed that it had lent Beats by Dr. Dre US$225 million.  In effect, Dre and Iovine bought those shares from HTC with money they borrowed from HTC through Beats by Dr. Dre, and then loaded the liability on the company they now controlled.

With HTC, themselves a manufacturer, invested into Beats by Dr. Dre with a combined stake of almost half a billion in both equity and debt, Monster Cables were no longer needed.  Monster were understandably unhappy with this and agitated for a better return on their investment – greater market visibility and a substantial payout.  In response, Beats by Dr. Dre ended their partnership with Monster Cables: Monster Will No Longer Make Beats Headphones.

On the surface, it looked counterintuitive, but it was a calculated move.  Monster Cables did not own the rights to a single drawing, idea or even the diagrams for the plastic parts: The Exclusive Inside Story of How Monster Lost the World.  From the very beginning, Monster Cables were outmatched.  When Kevin Lee, son of founder, Noel Lee, went to Los Angeles to negotiate, he had only a bachelor’s degree, no business experience outside of working for his father and no legal support.  He went into a meeting alone, against two men and an entire corporate team.  And in their desperation to enter a new market before their old one collapsed, got into a partnership where they built a business for a rival for free and never realised it until it was too late.

A few months later, Dre and Iovine took advantage of HTC’s financial struggles and bought the remaining 25% from them for US150 million.  Considering the market share and the actual value of Beats by Dr. Dre, this was a bargain.  Dre and Iovine had full control of the company now, which was the next part of the plan.

Ending the agreement with Monster Cables cost them hundreds of millions, and they did not take it kindly.  Considering their litigation history, they predictably tried to sue.  Before the case could go to court, in January 2014, Beats by Dr. Dre revealed its streaming music service.  This was the business they actually set out to build, instead of questionable headphones.  It was a hit with critics, and its success brought a bigger fish to the table: Apple.  Before June 2014, Apple agreed to buy Beats by Dr. Dre for US$3.2 billion, making Dre and Iovine billionaires, and changing the company name to Beats Electronics LLC.

Monster Cables filed a suit, claiming, among other things, that Beats by Dr. Dre stole proprietary headphone technology, that Beats by Dr. Dre unilaterally ending their partnership was illegal, and that Monster Cables were entitled to a portion of the billion-dollar Apple deal.

Here, Monster Cables had not considered the consequences of its actions.  It was outplayed, and still refused to accept that it was outplayed.  Apple was brutal.  Monster Cables had its rights to manufacturing Apple’s products revoked: Apple Revokes Monster’s Authority to Make Licensed Accessories.  How bad is this?  Consider this: Apple Revokes Monster's 'Made for iPhone' License Following Beats Lawsuit, where “According to Monster, 900 of its more than 4,000 products produced since 2008 have been made under the MFi program, and the company has paid out more than $12 million in licensing fees since that date.  Monster lawyer David Tognotti says the move is excessive and ‘shows a side of Apple that consumers don’t see very often.’

David Tognotti, the man who justified Monster Cable’s litigation excesses against smaller businesses, finally said, “Apple can be a bully.”

On the 30^th August 2016, not only did Monster Cables lose its suit against Beats Electronics, Beats Electronics countersued for legal costs.  And this is how a hustle works on a massive scale.

Typos Can be Deadly

Typos can be deadly for companies.  All limited liability companies in the United Kingdom are required to register with a government agency called Companies House, which records financial statements and other corporate information.  This is their equivalent to Singapore's Accounting & Corporate Regulatory Authority.

In 2009, Companies House reported that Taylor & Sons Ltd., a 124-year-old engineering company, had been declared insolvent.  That was news to the management and employees of Taylor & Sons, a very much functioning company.  Almost immediately, they were plunged into crisis.  Believing the company had collapsed into bankruptcy, customers cancelled orders, contracts were declared void, and suppliers stopped offering credit.  To compound matters, the company’s managing director was on vacation, causing clients and creditors to believe he had fled the country.  Operations slammed to a halt, and Taylor & Sons found itself forced to close for real.  All 250 employees were laid off.

As it turned out, Companies House actually meant to record the closure of Taylor & Son, an entirely different company from Taylor & Sons.  The now-liquidated Taylor & Sons sued Companies House and won; the judge ruling the agency completely responsible for the collapse of the £8.8 million company.  Now, if they had some form of liability protection, they could have mitigated this immediately.

Transitioning Financially When a Shareholder or Director Dies

Business succession planning using insurance is the art of structuring policies to address the potential issues that may arise in the event of the passing or incapacitation of a shareholder, director or key person in a business.  What are the issues that may arise?  This depends on the status of the person who passes away.  Businesses have executive and non-executive directors, major and minor shareholders, and they may have gearing.

Consider what would happen to your business if a stockholder passes away.  There are several immediate scenarios that will develop.  The most obvious is to continue with the heirs as stockholders.  They may be either as employees or as non-employees.  This is essentially about protecting your legacy and your family.

Consequences of Uncertain Shareholdings

When a major shareholder or an important member of the management team passes away, this creates concern with the financiers, trade creditors and trade debtors.  The financiers may decide to call in their investments.  This will crash the price of the stock and severely affect the cashflow.  This is especially certain if the financier is a bank or venture capitalist.

Trade creditors may also call in their loans.  This is a pre-emptive move by most banks when the deceased is one of the guarantors of the loan.  Or, the bank may raise the interest rate or vary other terms of the loan, including requiring more collateral.  Please note that a private limited does not necessarily protect you from the debts of the business.  Most loan contracts, especially with the bank, stipulate that the board of directors in their entirety are personally responsible.  This means, if the deceased shareholder was the one who took that loan on behalf of the company, even if you were not fully aware, and the bank decides to call in the loan, and the company cannot pay it back, they will go after you.  And the bank will always go after the director with the most assets first.  What this means, is that the death of another director can bankrupt you.

Also, you will find that your debtors will suddenly be difficult to collect from, especially if this is a large debt.  This is due to the concerns above.  If the company is declared bankrupt due to the escalating creditor issues, the debtors need not pay back any debts.

Heirs as Shareholders

The following are the factors we have to consider for the heirs of the stockholders.  After all, they have no actual relationship to the business beyond financial interests.  If they are not employed by the company:

1. Will they push for greater cashflow from the dividends?

2. Will they oppose long-term plans that might impact cashflow in the short term?

3. If the heirs are majority shareholders, will they remove you from management?

4. If they are minority shareholders, will they cooperate with management?

5. If the heirs are minors, can you cooperate with the guardians or trustees?

6. Would you be comfortable with your family being dependent on the business when you are deceased?

Heirs as Employees

If they are employees of the company, there are further considerations:

1. Do they have adequate management skills?

2. Do they have experience in the job?

3. Will they work with the management team?

4. Are they worth the same remuneration as the deceased?

5. What if there are more than one heir – can you afford their salaries?

6. Will they be worth the remuneration package?

Dealing with an External Buyer

Supposing the heirs, as is most likely, do not want to be part of the company.  They will likely sell their shares.  Even with a right of first refusal option to buy back the shares, the company may not have the reserves to do so without seriously impacting the cashflow.  In such a case, it is most likely that a third party will buy the shares.  These are the following points to consider:

1. What if the buyer was a business rival?

2. Even if not, can you accept any outsider buying into the company?

3. What is the likelihood that the new shareholder will have an alternative vision?

4. If they are the majority shareholder, will they remove you from management?

5. If they are the minority shareholder, will they share the vision of the management team?

6. If they push for a place in management, will they be worth the remuneration?

7. Will they push for increased dividends?

8. If you are the deceased, can you ensure that your family get a fair price for your shares, especially if they may not be familiar with the industry or the sale process?

Selling your Stake to the Heirs

These are the immediate questions raised on the most basic scenarios.  Essentially, if your interests are not protected, it is easy to lose out.  Even should you decide to sell your shares to the heirs due to an untenable position, you have to consider the following:

1. Can you stomach losing what you built?

2. How will the heirs fund it such that you can get a fair price?

We have not even addressed premium prices.  In this case, the correct suite of life insurance policies can address the cost of the purchase at a premium forward pricing, the issues of the family income and the estate taxes.

Buying the Heirs’ Stake

Should you decide to protect your position to buy the heirs’ stake, then you have several things to consider.  The three most major are: price, funding, and payment schedule.

Price

The price is determined by negotiation, and in most cases, the negotiation begins after death, either yours or another shareholder.  That means, if your family is negotiating the sale price of your stake after your death, you have no input.  And they might not have all the facts.

Funding

How will you fund this?  You can borrow, use personal resources or take from the sinking fund if any.  None of these are ideal.  How soon can the funds be available?  And what happens should the price of the shares vary greatly – upwards or downwards?  If the purchase is funded from existing resources in the business, can the cashflow take that sort of pressure?  Will it impact future earnings if it is taken from the working capital?  Will it affect the credit rating of the company?

Payment Schedule

How much room do you have to manoeuvre?  It is likely that the seller would like the funds upfront and will not tolerate a long payment schedule.  Can you imagine paying an inflated price for shares that have dropped in the meantime?

The Solution

This begins with a properly arranged and correctly worded buy and sell agreement.  This is the most straightforward, cost-effective method to protect the interests of all parties equitably.  This is how it works:

1. A buy and sell agreement sets the price of the stake upon the death of every shareholder.

2. The price is given at a premium of the stock to ensure that the estate of the deceased is satisfied.

3. The price also satisfies the remaining shareholders by creating a price ceiling.

4. Such an agreement can also lock out undesirable buyers, such as business rivals.

The next question is how to fund this?  We fund it through life insurance policies on the life of the shareholders.  This may be bought by the company on the shareholders, or by the individual shareholders on each other.  The manner of this is important due to taxation concerns.

This being an insurance policy, it can be triggered upon the death of the shareholder, or upon his incapacitation and inability to continue with the business, depending on the type of policy and extent of coverage.  Because this is tied up with the buy and sell agreement, the buy and sell agreement becomes a fully funded agreement.  It has the following advantages:

1. It assures the heirs and the surviving shareholders have the financial strength to fulfil the sale of the shares.

2. It assures them also, that they will get an acceptable price that is a premium on the worth of the shares.

3. Since the company is not obliged to remit the entire sum claimed, only the sum of the buy and sell agreement, it can buy a higher value policy and use the difference to offset the cost of replacing a member of the management team.

4. This allows a quick clean break by facilitating the smooth sale of shares, eliminating one aspect of ownership uncertainty.

5. The estate of the deceased receive the funds quickly, in one lump sum.

6. It improves the credit rating of the business immediately.

7. It assures the continuation of the business and addresses transition of ownership.

8. Depending on how the value of the policy and the obligation of the buy and sell agreement, this also allows the business to offset any debt should the bank or another creditor decide to call in a loan.

Essentially, by putting in place a proper buy and sell agreement coupled with the correct life insurance policies, we have addressed all these concerns, ensuring the continuation of your business.