Many family-owned businesses are unprepared for the moment when life takes an unexpected turn. Owners of a successful family company are frequently reluctant to address what happens to the business when death, divorce or unforeseen life events occur.
In not addressing these issues, the success Mom and Dad created and want to pass on to the children and grandchildren quickly disappears. Family squabbles and litigation can ensue, and a company can be forced to sell its assets and close up shop.
The final misfortune comes when a judge determines how to slice up the assets of the company to benefit all the shareholders, no matter who they are and how they came to own their shares.
Can such anguish by avoided?
Yes. By drafting a shareholder buy-sell agreement it is possible to put directions in place that are agreed to by all members of the family. These directions prevent others from taking what has been created. Shareholder buy-sell agreements shield the company when unintended beneficiaries like a divorced spouse, a widowed brother-in-law, a step-grandchild, as well as creditors, make claims on the business.
When working with an attorney to create a buy-sell agreement tailored to your specific needs, you should concentrate on effectively managing four areas that most often create conflicts within family businesses:
Agree on the purpose or purposes of the business.
Should the company provide a nice retirement income for Mom and Dad who worked so hard to build the business? Or should profits be put back into the company to grow it, as the children may want? Shareholders may be a combination of the first generation (who created the business) and the second/third/fourth generation (managing the business). The goals of each generation will probably differ. The answer will require a compromise by all parties at the table.
Have shareholders agree on who can own stock in the family business.
Do you want Crazy Uncle Eddie to be a shareholder with a vote? Or your brother’s wife’s children from a prior marriage? By restricting ownership, unexpected shareholders, along with their issues and differing opinions, can be kept out of the business. Restrictions also can be placed on the shares in a buy-sell agreement so that proper estate planning can still be done, and each branch of the family tree is able to give their ownership to their family and to do estate tax planning. It is important to have the estate planning attorney for each shareholder aware of the business agreements so that estate plans can be correctly drafted.
Agree on how the company will be valued.
Your father may think the company is worth millions, but your uncle thinks it is worth thousands. Be prepared to balance competing interests to determine the company’s value. For instance, the selling shares may want the highest possible value, while the buying shares may want the lowest possible value. An agreed-upon formula has to take into account unknown facts like what will the company balance sheet and financial future look like when an event occurs triggering the buy-sell agreement? Business planning and tax planning should work together on defining a valuation process, so that all possible income, corporate, gift and estate tax implications are considered.
How will the buyout be financed?
A buy-sell agreement frequently will envision life insurance on key people to fund a buy out at death. What if the key people are no longer insurable? If insurable, what type of insurance is appropriate and what are the various tax implications? What about using a promissory note secured by the stock, or unsecured, for payment over time? How to make the payment, and how quickly to make the payment, also are crucial questions in the process.
Death, divorce, creditors and disability are facts of life. Consider them carefully when planning the future of your business so that if someone in the family business experiences a setback, a process will be in place to help smooth the transition for the shareholders and the company.
Mixing family matters with complex finances is sure to create highly charged discussions. Many family-owned businesses simply avoid planning, hoping that complicated matters will resolve magically. Don’t fall into that trap. Instead, devote a concentrated amount of time today to the necessary planning, and then you’ll be free to manage your family business knowing that life’s twists and turns will have little impact on your fortunes.
NH Business Review, April 1, 2005
By Sheila Christie