Transitioning Your Business: Do You Have Agreement?
By: Martha Sullivan
Every day, I work with many different types of family businesses and family dynamics as they plan for the future of their companies. One specific client has been on my mind this week, wondering whether they’ve made progress on a key recommendation we provided.
This family business is not so unusual. There are multiple generations involved in the business. The patriarch is in his 80’s. His three children are all in their 50’s. The grandchildren range in age from high school to late 20’s. The patriarch and his spouse hold majority control with the remainder split equally among the three adult children.
The patriarch is influential but not active in the daily business. Two of his three children are active in the business and one is not. Of the two that are active, one is deeply involved in management whereas the other is barely participating at all. The latter shareholder is spending more time on hobbies than work. However, the two “active” owners are compensated identically based upon the father’s directive. The grandchildren with the greatest interest in coming into the business are the off-spring of the active-but-not-so-involved child. The offspring of the other two siblings have no interest in working in the business.
As you might imagine, there are varying perspectives on succession plans for the company. Questions swirl about regarding how hard and much longer the adult children want to continue to work in the business themselves, whether the grands will ever really come work in the business as active owner-managers, and if the adult children want to remain shareholders at all.
We’ve had some great conversations around these issues and are working together to arrive at potential strategies. Some shareholders do indeed want to diversify their portfolios and sell their shares where others do not. The patriarch can’t understand why anyone would want to sell. The path forward will undoubtedly entail someone leaving the business, either by selling shares or, in the case of the patriarch and matriarch, their passing.
There is one major fly in the ointment. There is no Buy-Sell or Shareholder agreement to guide a transition of ownership. The only direction is the stock certificate itself. It says that shares can’t be sold outside of the family. Period. End of story. Clear as mud when the time comes to bring someone new in or buy someone out.
The family and the business have no direction whatsoever as to:
Valuation: What is the agreed upon approach to value the business and the share price? Is it reviewed, agreed-upon and certified on a regular basis? What if parties disagree? What if the original agreed-upon value hasn’t been updated in years despite tremendous growth? How will the valuation address issue of marketability and/or control discounts?
Employment: To be an owner, do you have to be active in the business? Are there stipulations on how active owners’ compensation would be established and set?
Death/Disability: What if a shareholder dies or is disabled? Does the estate hold the shares or is there an obligation to buy those shares back? By who? Would the company or the other shareholders have to come up with the cash? What terms drive the redemption and pay out for timing, financing, etc.? Is it affordable? Is it fair? Is life insurance an integrated tool?
Marital: What happens if a shareholder gets a divorce in a marital property state? Does the former spouse become a shareholder? Is there a forced sale of shares? How is the stock valued in that scenario?
Sale of Shares: Under what circumstances may a shareholder sell their shares? To whom? Who has first right of refusal? (There are cash flow and tax implications to whether the company buys the stock back versus the other shareholders.)
Alignment: What does an individual shareholder’s Last Will & Testament say? Are the documents aligned? Where do they conflict? What is the true desired outcome?
Our recommendation to this family was clear, direct and urgent: take all efforts necessary to come to draft and execute a Buy-Sell agreement with help from a qualified attorney. Immediately. While life is still reasonably good, third generation family members have not been brought into the company and you, for the most part, get along.
There is always a risk that death, disability or divorce can bring an end to one’s ownership in a business. The fact that all the shareholders in this family were, shall we say, of a certain age underscored this risk even more. The dynamics of this family alone set the stage for chaos. Upon death of one of the shareholders, particularly if it were one of the second-generation shareholders, there would be confusion, disagreement, and likely legal action. Without a guiding document, survival of the family itself could be threatened.
As a family and a family business, they owe it to one another to set a path for transitions in and out of the business. The long-term health of their relationships and viability of the company depend on it.
What about you? If you’re a business owner with co-owners, do you have a guiding Buy-Sell or Shareholder Agreement? If yes, when was the last time you all looked at it and made sure it reflects your current business? If no, what’s stopping you?
Let me know your thoughts. I’d love to hear from you.
Martha Sullivan’s career has wound many curves, from a budding Information Systems graduate, to consulting in a CPA firm, to controller and CFO positions, and then back to consulting. She has always been committed to helping others accomplish their goals.