Most business owners have given some thought to what will happen to their business when they retire. Far fewer have adequately addressed what happens if they die, become disabled, get divorced or simply decide they no longer want to be in business with their partners.
The problem is that a business succession plan is not necessarily the same thing as an estate plan. And having an operating agreement or shareholders’ agreement does not mean that the important questions have been answered.
Consider a few common scenarios.
A 50% owner of an LLC dies. Does the surviving spouse inherit voting rights or merely an economic interest? Can the surviving owner purchase the deceased owner’s interest? If so, at what price and on what terms?
A founder becomes permanently disabled. Who makes business decisions? Does the other owner have the right to purchase the disabled owner’s interest? How is disability determined?
Two business partners decide they can no longer work together. Is there a mechanism for one to buy out the other? What happens if neither can afford to do so?
These are not hypothetical concerns. They are the kinds of problems that can turn an otherwise successful business into an expensive legal dispute.
A properly designed succession arrangement should address several issues. It should identify the events that trigger a buyout, establish a workable valuation mechanism, specify payment terms and determine who has the right or obligation to purchase the departing owner’s interest. It should also address whether life or disability insurance will fund the transaction.
Valuation deserves particular attention. An agreement that simply provides for “fair market value” may leave the parties arguing over what that means precisely when they are least inclined to agree. A fixed valuation should be reviewed periodically while an appraisal mechanism may provide a more reliable alternative.
Equally important is coordination. The operating agreement or shareholders’ agreement should work with the owner’s estate plan, insurance arrangements and any applicable restrictions on transfers. A provision in one document can undermine the intended result of another.
The best time to negotiate a business succession arrangement is when the owners are getting along, the business is operating normally and everyone has an incentive to reach a reasonable agreement.
Waiting until a triggering event occurs is usually considerably more expensive.
A succession plan should not merely determine who gets the business. It should determine what happens to the business, who controls it and how the departing owner’s economic interest is handled.
If you own a closely held business, it may be worth taking another look at the documents governing what happens when you are no longer there.
You may also enjoy:
- When Limited Liability Fails: Personal Exposure for Business Owners
- Business Plans: A Complete Guide, Part 1
- Simple Guide to Forming an LLC
- Is Your Operating Agreement Complete?
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