Ownership Agreements: 3 Common Mistakes
Beverage manufacturers–breweries, wineries, and distilleries–are often the creation of a core group of owners. One of the owners might be the mad-scientist brewer, who loves to create new style-busting beers. Another might be the marketing genius, who believes that a beer can be sold with the right branding and marketing. Still another might be the financier, who knows a good business opportunity when he or she sees it. Bringing these personalities together to create “The Brewery” or “The Winery” or “The Distillery” is a wonderful thing.
To help owners come together and stay together, they need an Ownership Agreement. Not only is this good business practice, but it’s also required by the TTB as part licensing process. Ownership Agreements go by different names–Operating Agreement, Shareholders Agreement, Partnership Agreement, Buy-Sell Agreement–but they all have a common goal: Provide a clear roadmap for the brewery owners to jointly manage and grow the business and to minimize the impact of conflict and adversity among owners.
Avoid These Change-of-Ownership Mistakes:
Every Ownership Agreement must deal with a change in owners. What happens when one of those original owners has to go his or her separate way? What happens when one of the owners dies? What happens when the owners cannot get along? Unless these questions are smartly addressed in the Ownership Agreement, the impact on the business could be disaster.
Bad Ownership Agreements:
Agreements that do not minimize the impact of a change in ownership—share one or more of the following three mistakes.
Mistake #1: Cookie-cutter terms that just don’t work.
It’s a mistake to think that a generic Owners Agreement is just fine for every company. The terms of an Owners Agreement must fit the unique characteristics of the company. These unique characteristics may include unequal ownership interests, differing roles in the company, particular family relationships among owners, and specific requirements of the industry. Unless the Owners Agreement takes into account all of the particular aspects of the company and its business, it’s likely that the Owners Agreement will fail when it is most needed.
The Solution: Every Owners Agreement must be carefully prepared to reflect the unique characteristics of the company and its owners, and it should be regularly reviewed and updated.
Mistake #2: Determination of the buy-out price is unreliable.
Often, the only way for an owner to separate from the company is through the sale of his or her ownership interest (stock, membership units, partnership interests, etc.) to the company or the other owners. This means that price matters.
If a fixed price set in the buy-sell agreement is too low, then the selling owner (or his or her family) suffers. If a fixed price set in the Owners Agreement is too high, then the buying owners or the company suffers. For this reason, it’s a mistake for the buy-sell agreement to state a fixed price for the ownership interest, unless the owners update the price regularly. It may be better for the Owners Agreement to contain a formula to determine the appropriate price, but even a formula can lead to problems if it depends on wrong or outdated presumptions.
Because of the problems associated with stating a fixed price or a formula, many Owners Agreement require an appraisal at the time of a transfer of ownership interests. An appraisal approach might be better, but it too can suffer from problems, such as failure to specify what facts the appraisal should take into account or gaps in the procedure for determining the price by appraisal.
The Solution: Whether a fixed price, formula, or appraisal, the price provision of every Owners Agreement must accurately reflect the specific nature of the company and it must be flexible and subject to periodic update.
Mistake #3: No assurance that cash will be available to pay the buy-out price.
Even if a buy-out price is determine appropriately, the buyer—the other owners or the company—must have the ability to pay it. Unless the Owners Agreement provides specific terms for the timing and source of paying the buy-out price, the buying owners or the company may be legally obligated to pay the whole amount immediately from operating funds. This debt obligation could cripple the company or the remaining owners.
The Solution: Every Owners Agreement should specify the intended source of funds for paying the buy-out price—often including life insurance and disability insurance policies—and a reasonable time period for payment of any unreserved amount.
Common Elements of a Good Owners Agreement
Owners Agreement should be unique documents, reflecting the particular characteristics of the company and its owners, but good Owners Agreement share common elements. When it comes to changes of ownership, good Owners Agreement:
- Prohibit transfer of ownership interests except as specifically provided;
- Deal with the transfer of ownership interests in the following scenarios:
- voluntary transfer by an owner;
- involuntary transfer by an owner (caused by divorce, bankruptcy, or creditor action, etc.);
- death of an owner;
- disability of an owner;
- termination of employment of an owner; and
- irreconcilable deadlock among owners;
- Spell out the procedure by which buy-out may occur in each scenario;
- Describe the method of determining the appropriate buy-out price;
- Describe the source of funds for payment of the buy-out price (e.g., insurance);
- Describe payment terms; and
- Describe what should happen pending buy-out.
Most important of all, no Owners Agreement is a good Owners Agreement unless it is signed by all of the owners, including persons who become owners after the Owners Agreement is originally signed.
How good is your Owners Agreement? Did you just pull it off the Internet? Do you understand your Owners Agreement? If you’re not absolutely sure, we can help ensure that your Owners Agreement is as good as your beverage. Contact us to schedule a consultation with a beverage attorney.
Because we’re attorneys: Disclaimer. Updated January 31, 2023.