Business Succession
Business Succession Planning
You’ve built a successful business and people are relying on you. What happens if you unexpectedly die or become disabled? Assuming less dire circumstances, what happens if you retire? These are questions that should be answered thoughtfully and well in advance. We understand these conversations can make your family and staff uncomfortable, and Penwell Law is here to make the process easier.
Owner Exits Due to Life Events
Begin by considering the best-case scenarios. If you have a clear successor, how can you leave them best prepared for success? Typically, you need a mechanism to transfer your ownership interest to them and funds to compensate your loved ones for that transfer.
The transfer of ownership is the easier piece of the puzzle, so long as (1) you set it up before the situation is urgent, and (2) you ensure it doesn’t conflict with your will or trust. A buy-sell agreement is an excellent choice for this type of transfer, as it dovetails with your company’s existing documents (such as the bylaws or operating agreement). Properly drafted, the buy-sell agreement establishes who is entitled to purchase your ownership interest upon certain triggering events (such as death, disability or retirement.) It includes a method for valuing the company and setting a purchase price, dividing pre-close and post-close liabilities and ideally identifies backup successors in the event your first-choice successor chooses not to take over.
Funding is also addressed in buy-sell agreements and may be handled through life-insurance policies, installment payment plans, private financing by your successor, or the gifting of certain percentages of ownership at designated intervals during the lifetime of the owner. In situations where an owner wishes to preserve an income stream for a loved one, a certain percentage of ownership can be held back to allow for ongoing distributions to that person, with managerial control specifically designated to the successor who is in charge of operations. Similarly, in the case of lifetime gifts, the owner may hold back voting/managerial control by gifting equity with specialized restrictions.
We recommend buy-sell agreements to family-owned businesses in particular, because it can head off undesirable scenarios following a tragedy, like widows and widowers being forced to take over, fights among siblings, chaotic and costly business interruptions and an exodus of staff due to uncertainty. According to the Harvard Business Review (citing the U.S. Census Bureau), “family businesses — companies in which two or more family members exercise control, concurrently or sequentially —represent about 90 percent of American businesses. Ranging in size from two-person partnerships to Fortune 500 firms, these businesses account for half of the nation’s employment and half of the U.S. gross national product.” We take the preservation of your family business very seriously and will work with you to develop a customized succession plan that honors what you have built. This includes working in close concert with your estate and tax planning attorneys to ensure your will, trust and business succession documents work together seamlessly.
Owner Exits Due to Disharmony & Sales to Third Parties
If you co-own a business with your spouse and are facing an impending divorce, what happens next? Similarly, what if you can no longer face working with your business partner? Though the latter is a platonic relationship, the legal issues overlap. Specifically, what mechanisms will you use to value the business? Who stays and who goes? How are negotiations conducted? Will you each have your own counsel? How will the remaining partner pay out the exiting partner?
Even in the most contentious situations, there are certain strategies you can implement to ensure fairness. For example, you can enter into a written agreement whereby the offering party must be willing to either buy out or be bought out by the other partner for the price they are proposing. This avoids lowballing. Typically, there are also provisions limiting the ability of the offering party to later reduce their price at the counter-offer stage.
For valuations, each partner can appoint an accounting firm who in turn appoints a third firm and an average can be taken of the three valuations. Or, to avoid the cost of three valuations, each partner can appoint an arbitrator or accounting firm and those two arbitrators or accounting firms will collaborate to pick one acting arbitrator or accounting firm.
If you are fortunate enough to still be in a state of harmony with your business partner (spouse or otherwise), we recommend you incorporate rights of first refusal into your company’s governing documents. This will allow you to match buyout offers made by third parties so that you can maintain control of your business. You can also draft installment sale provisions which prohibit sales to third parties altogether and provide a mechanism for buying your partner out over time.
Employee Exits
As an employer, you may be offering equity or profit-sharing interests to your top performers. This can be a fantastic way to recruit and retain talent, but what happens when that person decides to leave? Or worse, what happens if you need to terminate their employment for poor performance or even malfeasance? Particularly in sales-based positions, you should make sure that (1) your business owns the customer accounts rather than the employee, and (2) you can either buy back or terminate ownership and profit-sharing interests upon the employee’s exit. If you fail to reduce these expectations to writing in an actual employment agreement, an exiting employee may have a valid argument that they are entitled to take their book of business with them. Penwell Law has extensive experience drafting and negotiating non-compete, non-solicitation and confidentiality provisions to protect your business.
In regard to equity and profit-sharing, we similarly recommend that you memorialize these awards in writing rather than relying on informal oral agreements. Ideally, such awards should specify what constitutes a termination for cause versus for convenience and outlines the ramifications for each. Likewise, key employees may want you to differentiate between a situation in which they leave of their own accord from one where they are forced out through unfair or retaliatory demotions and pay reductions. Fairness usually dictates that an employee terminated for convenience or forced out unfairly should have the option to buy out certain vested equity grants.
You should also make sure that any grant of equity or profit-sharing interests adequately explains how those shares or interests will be valued. For example, if an employee is granted phantom equity, are they entitled to the difference in value of your company’s stock between the day of the award and the day they cash out? Or, are they simply entitled to the value of the company’s stock on the day they cash out, whatever that value may be? Taxes are also important, and employees should be warned that you do not intend to “true up” their award to account for income taxes on the proceeds.
Contact Us Today!
Whatever your business succession planning needs may be, Penwell Law is here to help. You can reach out to our team at info@penwelllaw.com with questions or to set up a free initial consultation, or you can book your free initial appointment with us here:
