In an excellent recent column for this newspaper, Jamie St. Clair of Key Bank noted that the successful transition of a business only occurs “when families are willing to start planning early, communicate clearly and enlist expert professional support.” This good advice is not limited to family-owned businesses. Any time a business is owned by more than one person, except perhaps when the owners are married, they should have a plan in place that addresses possible future changes in the business, the parties themselves, and their relationship.
I don’t know whether it’s reluctance to acknowledge that we all can be replaced, a desire to avoid a situation that may put co-owners in conflicting positions with each other, or a wish to simply avoid asking and answering hard questions, but business succession planning rarely gets the attention and discussion it deserves. Talking about death, disability, divorce and so forth is never comfortable, but it’s more comfortable than a lawsuit over those same issues down the road.
In this column I will call all owners, whether shareholders, members of a limited liability company or partners, “partners.” I present it as two male owners in the interest of simplicity, not bias. The principles remain the same for everyone.
Let’s talk first about the death of a partner. When one partner dies, his share of the business passes under the provisions of his will or to his heirs at law. Does the remaining partner really want to operate the business with the deceased’s widow or his children? Probably not. The survivor selected his partner. He didn’t select his partner’s family. I like to provide that on the death of a partner, his estate is compelled to sell his share of the business either back to the partnership or to the surviving partner. This provides the deceased partner’s estate with liquidity and allows the surviving partner to continue to run the business.
What if a partner wants to be paid for his share and get out of the business altogether? The partnership interest is, after all, his property and he has every right to sell it to whomever he wants. I like to provide that if he wants to sell his interest to a third party, he first must offer it back to the partnership or the remaining partner on the same terms and conditions.
There are also cases where the interest may be involuntarily transferred. A trustee in bankruptcy could sell the partner’s interest to anyone. A guardian or conservator of an incapacitated owner could sell the interest to some third party. What about a claim by a bitter ex-spouse? Some provision should be made to protect the remaining owner from being in an involuntary partnership with a stranger. In the event of any involuntary transfer, the partnership and/or the remaining partner should have at least a right of first refusal to acquire the interest being transferred.
When those issues have been addressed, the subject of price needs to be discussed. An agreed upon fixed price is easiest. If that is the approach, I suggest providing for an annual review and adjustment tied to some regular event, such as filing the company’s tax return. Otherwise, such reviews usually never happen. Sometimes a formula is used that automatically will adjust the price in the future. Sometimes the price can be set by appraisal or arbitration, but these approaches inject a factor of uncertainty that makes some people uncomfortable. Whatever approach is chosen, some agreement on price or at least how to arrive at a price is essential.
What if the company or remaining partner is unwilling or financially unable to pay the price? Provision may be made for some portion of the price or all of it to be financed by the seller. Except with very well-off owners, insisting on cash in full can result in a forced sale of the business at a great loss to both parties.
Sometimes the parties may use insurance to fund a buyout in the event of death. If that is chosen, think about whether the partners or the company will pay the premiums and own the policy. What if the insurance proves to be inadequate? How will the balance be paid? What if the insurance is more than the purchase price? Who receives the excess? These things all need to be discussed.
If the business turns out to be a complete failure, none of this will matter. If it prospers, all of these questions will need to be asked and answered someday. People do die, retire and change their plans. It’s much easier to have these discussions early on rather than when a crisis has arrived. A little planning now can save expensive and unpleasant litigation later.