You’re starting a business that involves other owners, investors, or family members. Everything is great! All parties get along fabulously and are aligned to the goal of making this new venture a success. You can’t imagine anything going wrong!
I can’t tell you how many times I’ve heard that sentiment from owners, only to see things go awry over time. It happens for many reasons – conflict around vision, goals, and values, lack of communication, business challenges or successes, money squabbles, etc. The unhappy truth is that messy breakups abound in business…consider Facebook and the Beatles.
As a business and exit planning consultant, one of the best pieces of advice I give owners is to plan for the worst and hope for the best. This is especially true when it comes to having your business agreements well thought out and executed prior to starting a business. With proper planning, you’ll not only have a clear understanding of how the business will be operated, but also how you or others can exit if it doesn’t go well.
So, what agreements should you consider having in place for your business, if you don’t already have them?
Shareholder (Stockholder) Agreements If there is more than one owner, you need a shareholder agreement that describes how a company should be operated and outlines the shareholders’ rights and obligations. It is also intended to make sure that shareholders are treated fairly and that their rights are protected. In addition, it allows shareholders to make decisions on whether outside parties may become future shareholders and provides safeguards for those holding a minority interest.
Where does the Shareholder Agreement come into play? Let’s say you are a minority owner in a business, and you want to exit. The agreement can outline the mandatory or optional buying-back by the company of your shares. It can also outline that an owner can’t sell to an outside party without giving the other shareholders or company the right of first refusal. And it can provide how the value of your shares are calculated should a buy-out occur.
Now, if you’re a 50/50 owner, another item that you may want to incorporate is a mandatory option to buy out the other shareholder after a period. In a 50/50 ownership situation, if the parties aren’t getting along and can’t come to agreement, without some forced option to exit out a shareholder or force the sale of the business, there is no exit. This is typically where lawsuits ensue. Again, plan for the worst and hope for the best.
Buy-Sell Agreements
This agreement stipulates how an owner’s share of a business may be reassigned if that partner dies or otherwise leaves the business, typically through disability or retirement. This agreement may also establish how value is determined depending on the reason for exit. Many times, these agreements are funded through life insurance policies to provide the cash for the business to repurchase a deceased owner’s share.
A current client has several family members that are minority/silent owners in the business. My client is the majority owner and is looking to grow the business but wants to exit the minority owners so that he has 100% control and can take on the level of risk he desires to grow the business. The current buy-sell agreement outlines the value of the stock and a buyout period, but it doesn’t allow for the forced sale of the minority shareholders’ shares. This can become problematic if the minority shareholders don’t want to sell.
How does the majority owner exit them from the business? If the buy-sell agreement stated that you had to be an active owner in the business to hold shares, this could force the sale of the stock. Without it, the majority owner is at the mercy of the minority owners until something happens to them forcing an exit.
Operating Agreements
This agreement is used to define the financial and functional decision-making within a limited liability company. It provides clear governance on internal operations according to the rules and specifications defined by the owners.
A previous client ran an LLC where there were four equal owners. All were family members but from two different families. The individual roles/positions they held in the business were very different, from President to Purchasing Manager. Because they were equal owners, they all thought they had equal decision making when it came to the operations of the business. Without a clear operating agreement, separating ownership from functional decision making can be a bone of contention.
The Shareholder, Buy-Sell, and Operating Agreements are some of the more common and critical agreements that you should have in place in your business. Thinking through all the potential situations and circumstances as you’re drafting the documents can provide clarity, prevent disputes, and create continuity of the business.
Do you and your partners have agreements in place to ensure the company - and your relationships - survive the ups and downs of business?
Reach out to our team if you need guidance to safeguard your partnership: (920) 770-4141 or info@journeyconsult.com.
Jayne McQuillan, CPA, MBA, Certified Exit Planning Advisor (CEPA) is the owner of Journey Consulting, LLC and author of the bestseller, "The Value Journey: How to Drive Profits, Build Wealth, and Exit Your Business on Your Own Terms."
Our firm is focused on providing business owners and their businesses with strategic planning, exit planning, financial expertise, and organizational improvement. We use a holistic approach within all of our services by aligning leadership with business strategy and outcomes.
Schedule your complimentary consultation to begin your Value Journey today!