BY: MONTE SCHATZ
Your everlasting summer
You can see it fading fast
So you grab a piece of something
That you think is gonna’ last
You wouldn’t even know a diamond
If you held it in your hand
The things you think are precious
I can’t understand
“Reelin In The Years” by Steely Dan
Donald Fagen and Walter Becker forged a lifelong friendship when they first met at Bard College in New York in 1967. Their mutual love of music was the common bond that formed their friendship and that led them to create the musical group they named Steely Dan. The group has sold more than 40 million albums worldwide.
The original six members of Steely Dan incorporated as Steely Dan Inc. (SDI) on October 31st, 1972 in the same month they released their debut album. On that same date SDI was formed, all six members signed a buy sell agreement that specifically would take effect upon the death of one of the shareholders. The agreement required that the corporation buy back the from the deceased individual shareholder’s shares based upon book value of the company with no valuation provided for goodwill. In fact, goodwill was to be specifically excluded in consideration of the book value. There never was an amendment or another buy-sell agreement drafted after 1972. With all these legal tools in place, what could possibly go wrong?
Walter Becker passed away on September 7, 2017. The only remaining shareholders at the time of Becker’s death were himself and Donald Fagen. Four days after Becker’s death, representatives of Becker’s estate and trust sent a letter to Donald Fagen claiming that the agreement contained a clause terminating the agreement when “all of the outstanding stock of SDI will be owned by a single stockholder”. Becker’s representatives also claimed that 50% of SDI’s goodwill should be retained by Becker’s revocable trust that held his shares of SDI stock recognizing Becker’s contribution to the creation of that goodwill.
Donald Fagen filed a lawsuit against the estate and trust of Walter Fagen claiming the agreement contained a clause that upon the death of any SDI shareholder, the corporation was mandated to purchase, and the deceased shareholder was required to sell, all the stockholder’s shares. Fagen’s attorneys argue that the termination of the agreement occurs only after the mandatory sell provisions of the agreement had concluded.
The lesson learned from this celebrity estate and buy-sell battle is that a regular review of a business plan is just as critical and important as regularly reviewing an estate plan. The Steely Dan buy-sell litigation illustrates the consequences of failure to regular review a buy sell agreement. Five steps every business owner should consider that enter into or have an existing business agreement are outlined below borrowing from some of Steely Dan’s own lyrics:
“Rikki Don’t Lose That Number” Parties to a buy-sell agreement should monitor their financials on a regular basis and review those numbers to see if their existing buy-sell valuations reflect a fair and reasonable value. As a business matures and prospers, its valuation increases. Perhaps Becker and Fagen should have revisited the agreement to consider some other formula other than book value. Clauses that lock in a superficially low valuation number to a survivor can lead to unnecessary litigation and disputes over valuation. Business owners should review this number to see if it still reflects a fair value of the company.
“Dirty Work” Structuring your valuation formula for best tax advantages. Don’t leave the valuation formula in a buy sell agreement become a potential tax trap. The buy-sell agreement valuation formula in the Steel Dan agreement was book value stripped of one of its most valuable assets–namely, goodwill. The IRS may see the valuation for estate purposes to be much higher that could leave Becker’s trust short of the necessary liquidity to meet a potential estate tax bill. The heirs of a deceased seller could be left lamenting, “I don’t want to do your dirty work no more” absent structuring the buy-sell for maximum tax advantages.
“Haitian Divorce” Draft the buy-sell agreement to contemplate a spouse. The Steely Dan buy-sell agreement did fortunately include provisions for any surviving spouse. Some situations and jurisdictions dictate inclusion of a spouse. Other situations may consider separating the business owner’s interest from the marital matters of a spouse. The business owner cannot disinherit a spouse, but proper funding and structure of the buy-sell agreement can avoid the business interests of the owner being disrupted by separate marital issues with a spouse. Review of the applicable state jurisdiction’s laws on marital and decedent’s estates should be reviewed. The goal should be, to borrow Steel Dan’s lyrics, “Oh-no hesitation, no tears and no hearts breakin’, no remorse, oh congratulations, this is your Haitian Divorce.”
“Do It Again” Review the agreement to assure that it contemplates several scenarios that may trigger a buy-sell. A buy-sell agreement may not contemplate all the changed business circumstances as it was originally written. Steely Dan’s agreement almost exclusively focused upon the death of the shareholders. There are 5 big D’s that should be considered in any buy-sell agreement:
- Departure (retirement, insolvency, voluntary or involuntary terminations)
- Dissolution (the corporation ceases to exist)
Any time there are major life changes of a party to a buy-sell agreement, it is time to reconsider the buy-sell provisions. Preferably, all these situations should be contemplated in the original buy-sell agreement. Regardless of how these provisions are addressed there is no substitute for reviewing the buy-sell. “You go back Jack and do it again”!
“Everything Must Go” Review and plan for what assets will be used when the remaining owners must purchase a departing seller’s business interest. A buy-sell agreement is only a piece of paper if there aren’t provisions behind the agreement to assure funding the purchase of the selling owner’s interest. Regular reviews of life insurance, company liquidity reserves or other funding vehicles to assure that the necessary assets are there to fund a buy out without severely hampering the remaining shareholders liquidity is critical. Nobody wants their business swan song to reflect the following Steely Dan refrain:
Talk about your major pain and suffering
Now our self-esteem is shattered
Show the world our mighty hidey-ho face
As we go sliding down the ladder
It was sweet up at the top
‘Til that ill wind started blowing
Now it’s cozy down below
‘Cause we’re goin’ out of business
Everything must go
“Everything Must Go” by Steely Dan ©2003