Our clients, Jenn and John learned the hard way regarding the crucial role of contracts. Jenn and John entered into a handshake agreement with Dad. After 15 years of hard work, the agreement was breached. Jenn and John were not compensated for the labour incurred over the 15-year period. Jenn and John hired Troy Valuations to quantify their loss. They were successful in their pursuit of justice for the breach of contract.
This case study illustrates the crucial role of contracts in family business transactions. A written contract would have prevented this situation by including terms for due diligence, written communication regarding effort expended and the amount of accrued, unpaid compensation between the parties.
The Pact for Prosperity
John was a capable engineer. Jenn was a competent corporate manager. Dad had two companies. The first was EngineeringCo that provided engineering consulting services to oil and gas producers to help optimize production and costs. Dad’s second company, AssetCo, was an oil and gas producer.
Dad enjoyed a long career building these two companies. John similarly provided engineering consulting services to oil and gas producers working as an employee at a big company.
As Dad aged, he began to think about his retirement. How much money did he need to live and how much did he want to work. The answer of course, was lots of money and little work. Dad realized that he had a made-in-the-family buyer for his EngineeringCo. John agreed to buy EngineeringCo for a fair price. It was a happy transaction as it gave John and Jenn a good start in their entrepreneurial journey.
The Promise and the Trust
For a few more years, Dad continued to run AssetCo. There came a time in which Dad preferred that someone else take the reins. Approaching Jenn and John again, Dad asked if they would manage AssetCo. The deal was struck: Jenn and John would manage AssetCo, but Dad would retain ownership. This gave Dad a steady source of income through his retirement with the promise to compensate Jenn and John in the future.
This unwritten agreement was supported by trust and family bonds. All parties agreed the first sale transaction of EngineeringCo was successful. Based on that trust, Jenn and John agreed to manage AssetCo without compensation, and would gain ownership of the company upon Dad’s death. For fifteen years, John and Jenn managed AssetCo to success while Dad enjoyed a very comfortable retirement.
Twist of Fate: Dementia and Death
As Dad aged, his health and then his memory began to fail. The family got together on friendly terms, John and Jenn managing AssetCo, funding the lifestyle for which Step-Mom and Dad became accustomed. Dad, Jenn and John frequently talked about the operations of AssetCo. Then Dad got really sick and his dementia got worse. There was talk in the family about getting a will and arranging the estate, but there didn’t ever seem to be time for it. Then Dad passed away. There was no will.
Because Dad died intestate, all Dad’s assets passed to Step-Mom. Step-Mom was not an engineer. She was not a corporate manager. She was not an entrepreneur. Without consulting Jenn and John, Step-Mom sold AssetCo to a buyer unrelated to the family for an amount less than fair market value.
Jenn and John were devastated. They had worked for years without compensation on the promise of future benefits. It was this unwritten agreement that exposed the crucial role of contracts. Jenn and John were horrified that Step-Mom would sell the company for such a low price. Following the sale, Jenn and John received no compensation.
The Quest for Justice
Jenn and John sought restitution in the courts, They found a reputable lawyer to plead breach of contract before a judge. It was at this time they engaged Troy Valuations.
We were engaged to quantify the loss of compensation by Jenn and John. We illustrated the success AssetCo enjoyed through the management of Jenn and John. We demonstrated no compensation was paid to Jenn and John for their efforts during the 15 year period.
Our comprehensive approach considered AssetCo as a client of EngineeringCo. This was the work that EngineeringCo was already doing for industry. Both Jenn and John were active in the operations of EngineeringCo. We undertook a detailed examination of the financial records and operational records of AssetCo and the industry in which it operated.
In our expert opinion of the loss of compensation, we relied on publicly available data and data private to AssetCo that was in the possession of Jenn and John. Using a broad spectrum of data sources, we calculated the loss of compensation of Jenn and John based upon the total hours of work expended. We referenced market rate management consultancy fees as determined by an independent professional body and de-escalated these fees by inflation rates over the 15 year period. To recognize the value of compensation foregone during the period, we determined the compounded value of investment interest.
The project required that we think creatively and apply our specialized knowledge to this complex situation. We were tasked with determining the value of the crucial role of contracts. Our expert opinion adhered to the high professional standards as set forth by the CBV Institute specifically tailored to the unique needs of our client.
The Resolution
The case was tried in a private arbitration before a judge. A court reporter was present to record witness testimony, including our own expert witness testimony.
The judge ruled in favour of Jenn and John against Step-Mom. He awarded compensation lower than our valuation, but greater than the amount Jenn and John expected.
Jenn and John were pleased with the outcome and learned the lesson about the crucial role of contracts.
Lessons Learned
This case study illustrates the crucial role of contracts in family business transactions. Formal contracts, even between family members, ensure compliance and enforce behaviour. It underscores the paramount importance of not just formalizing agreements, but also of a meticulously crafted valuation approach that respects the nuanced dynamics at play.
At Troy Valuations, our commitment to upholding the rigorous standards set by the CBV Institute is unwavering, as demonstrated in our handling of this case. Our valuation, which estimated the losses incurred by the clients due to the alleged breach to be between $2.4 and $5.5 million, was grounded in a comprehensive analysis that considered both the loss of compensation and the compounded loss of investment interest, as mandated by the Judgment Interest Regulation.
This story serves as a poignant reminder of the crucial role of contracts that play in safeguarding the interests of all parties involved in a business, especially within family-run enterprises. It also highlights the invaluable peace of mind that comes from engaging with seasoned professionals who can navigate the complexities of valuation with empathy, expertise, and precision.
If you find yourself at a crossroads in a similar situation, remember the path to clarity and resolution is through informed, expert advice. Troy Valuations stands ready to guide you through this process with a comprehensive, no-obligation consultation, ensuring that your business, like your relationships, is built on a foundation of trust, respect, and professionalism.