© Leo Blanchette | Dreamstime.com

It was Benjamin Franklin who once stated that “an ounce of prevention is worth a pound of cure.” He was telling us that it is better to try to avoid problems in the first place rather than try to fix them once they arise. For small entities serving as manufacturers’ representatives, an ounce of prevention may be found in a contract, often called a Shareholder Agreement, between its owners that specifies how the entity will be run and what happens when certain events occur. For entities with a small number of owners who are active in the daily business operations, such agreements are essential to the longevity of the operation.

A significant number of my clients are entities with a limited number of owners involved in promoting the goods/services of the manufacturers they represent. The owners of these entities are focused, hard-working and dedicated to the pursuit of their sales objective, but on occasion they fail to address the necessary legalities of the entities they own, sometimes exposing the fruit of a lifetime of hard work to unanticipated consequences upon certain “triggering events” such as a co-owner’s (i) voluntary transfer his ownership interest, (ii) death, (iii) bankruptcy, (iv) termination of employment, (v) divorce or (vi) disability.

For example, let’s assume that you own an interest in an entity in the representative agency business along with a small number of other owners who are also actively involved. It’s a team effort dedicated to making a profit. Let’s also assume that an owner decides to sell his ownership interest to a third party (possibly even a competitor), contrary to the wishes of the other owners. Or perhaps one of the owners decides to pursue another opportunity and fails to contribute as in the past, and advises that he wants either inflated compensation or continuing dividends for his ownership interest in your entity. What happens if one of the owners dies, leaving his ownership interest to the heirs of his estate who have no sales experience? How would the company cope with the divorce of an owner resulting in a court judgment awarding the ownership interest in your entity to an ex-spouse not involved in the business?

In such instances, the survival of the entity and the well-being of the remaining owners can be maximized with some planning and forethought, friendly negotiation, and a documented agreement (ounce of prevention). Such written agreements come with varying titles such as Shareholder Agreement, Buy-Sell Agreement, or Redemption Agreement, to name a few, and they address varying goals such as limiting the transfer of the ownership interests, providing for the company (or its remaining owners), to purchase the interest of an owner who leaves the employment of the company or becomes deceased, disabled, divorced, or retired. Properly structured, such agreements can also provide a means to resolve managerial deadlock, maintain proportionate ownership, give protection to minority interest owners, and, with the use of key-man insurance, provide liquidity for the estate of a deceased shareholder.

It’s been my experience that the most difficult (though probably the most important), item to negotiate for such agreements is the “value” or price that is to be given to the shares being re-acquired by the remaining entity or its owners. Should you use “book value,” “fair market value,” a multiple of EBIT, a number determined annually by the company’s board (or its owners), or some other negotiated sum? No matter the difficulty in agreeing on the price, it’s always easier (and less expensive), to reach an agreement before a triggering event occurs and the resulting desire or need for a re-purchase when the parties’ positions are polarized and emotionally charged. Failing such an agreement, many have had to resort to the courts and the use of expensive experts to argue over concepts such as the discount of minority interests and value of goodwill. Too often, such arguments will kill the golden goose and most certainly divert the focus of the entity away from its main business objectives.

While value determination may be difficult, there are alternatives that lend flexibility to ease the process. You may want a different means of determining the value attributable to differing triggering events. For example, you may be more motivated to pay a larger value to the family of a recently deceased owner than you would to the non-involved ex-spouse who was awarded part of the entity ownership as the result of a divorce. You may want to pay a higher value to an owner who has become unable to work due to a disability than you would to a non-productive owner that has decided to go on a previously unannounced sabbatical.

Such agreements are somewhat like a business “pre-nuptial” in that they anticipate certain events that may occur in the future and then provide for a means, method, and price for addressing each situation. Common problems of such entities are anticipated in advance and avoided by agreement once they are identified, rather than trying to fix them when they arise. The process of planning such an agreement has the added benefit of focusing the business plan and clarifying the expectations of the owners. This ounce of prevention is likely to pay off in more than a pound of cure.