I just returned from a week of sightseeing in Boston. Reading a book on Thomas Jefferson ignited my interest in the pre and post Revolutionary war periods. We did all of the normal touristy stuff. At the end of our week, we took a Ghosts & Ghouls tour of Boston burial grounds. As part of the tour I was hanged at Boston Commons. Please send money to my not so mourning family. Then the tour guides married me off to a serial killer. She killed her first four husbands before being slain by her fifth. It was a tough week.
September 2012 was a tough month for me. Actually, it wasn't so much tough on me but on my clients. Four died in one month. Our staff joked that being my client was a terminal disease. Three of these clients had their affairs well in order. But one didn't. He owned a business with a partner. He died without a buy-sell agreement or an operating agreement.
Fred and Al owned an IT business that served the federal government. They provided fail over services for government agencies. If you had computer operations in say... the World Trade Center, and someone flew a plane into the building destroying your IT facilities, Fred and Al made certain your operations continued as usual. You can probably understand that Uncle Sam had quite an interest in their services.
Fred and Al were both in their mid-forties and in good health. Then Fred got run over by a truck, literally. He died instantly. Fred and Al had neither a buy-sell agreement nor an operating agreement. What happens when your business partner dies, and you don't have the legal documents to ensure an orderly transfer of the business?
You end up with unwanted partners, and they aren't usually the silent type. Al was contacted by a personal injury attorney representing the two daughters from Fred's first marriage. Al barely knew the daughters existed. Since, there were no legal agreements regarding what happened to the business upon Fred's death, the attorney volunteered to draft an operating agreement for the business installing the two daughters as Al's new partners.
Here's the problem with allowing a personal injury attorney to write an operating agreement in these circumstances..... Personal injury attorneys don't know a damn thing about estate law, at least this moron didn't. Fred's daughters were not the rightful owners of Fred's share of the business even though they were his heirs. In Virginia, Fred's estate owned Fred's share of the business. The attorney was busy writing an invalid agreement.
I referred Al to an estate attorney, who began the process of probate for Fred's estate, working with Fred's second wife to close out the estate. In Virginia, counties administer the probate process. Periodically, the estate executor files an asset inventory and reports on the progress in winding up the estate. Besides the legal fees, the county requires substantial probate fees based on the value of the estate.
Fred's share of the business was his primary asset. So the estate engaged me to provide a valuation of Fred's share on the date of his death. Al, and the estate attorney, hoped to use this valuation to settle the estate and buy out any claim on the business from the daughters. Hoped is the key word here.
If you are caught in Al's situation, you can be certain of one thing. The heirs of your business partner will smell the pot of gold. They are thinking millions of dollars for their share even if they peed in his porridge while he was alive. It's party time, baby. Fred's daughters were no different.
Fred and Al had a nice business, but it was really just two well paying jobs. They provided all of the services personally, relying on their combined forty years of engineering expertise creating fail over systems. That doesn't make for a valuable business. For Al to continue the business, he needed to hire someone with similar expertise. These people aren't cheap. In fact, it was going to cost more to replace Fred than Fred's salary.
Fred and Al were very valuable computer engineers, but the business itself was worth pretty much nothing since the pool of potential buyers was almost nonexistent due to the technical qualifications required of a new owner. I valued the business at just the cash on hand and the receivables at the date of Fred's death. Fred's half of that was about $100K, hardly the millions his daughters envisioned.
Are you surprised that they weren't happy with me? Al was faced with tens of thousands of dollars in legal fees, not to mention the business disruption. He offered the daughters the opportunity to pick a business valuator of their choice. But, that would cost them money. They were content to threaten legal action and delay the closing of the estate. The county was after the estate to close and continued to impose more fees. The business was being ignored.
In frustration over the lack of progress getting the business out of the estate, Al hired a litigation attorney. Al's attorney asked the daughters to submit what they thought the business was worth telling them that Al would either buy it from the estate for that price or sell his share for that price. They would then be obligated to buy Al's share at his option. Of course, they refused. They had no money, but they had plenty of attitude.
Al's attorney then told the daughters that Al was resigning from the business. Since there was no operating agreement, Al was free to withdraw from the business and form his own new company. Of course, he couldn't take any existing contracts with him, but those contracts were worthless without him. The daughters would never be able to manage the existing contracts, and the business would fold. Then Al could bid to get the contracts back.
The daughters' attorney called for a mediation meeting and the daughters settled for almost the exact value I had calculated. Al had his company back after spending $20K or so, not exactly a happy ending, but a satisfactory one in the end.
Dying without buy-sell and operating agreements is malpractice for a business owner. You are ensuring heartache for your family. Of course, if you hate your partners, spouse, and family, go for it.
Thanks for reading! For real tax and accounting advice, please visit the main S&K web site at www.skcpas.com. Also, please like the "How to Screw Up Your Small Business" Facebook page.
Until next time, let's do it to them before they do it to us.
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