Small Business Partners Need A Written Plan Regarding The Departure, Divorce, Death or Bankruptcy of Another Partner
I read a blog post by California Bank and Trust on Rules entitled “Create Effective Rules for Your Family Business Meetings.” Here is a link to the post: link
I had to chuckle as most small businesses and family owned businesses are pretty informal. The post does make some good points. One of them was “stay with the big picture; don’t get caught in the details.” But we all know the the devil is in the details and the cause of much contention in small businesses in which there are multiple owners. It really makes sense to be transparent. One way to ensure transparency in dealings with other owners is to begin transparently with a Buy-Sell Agreement. This is a contract between owners that determines what happens if a co-owner dies, is forced to leave or chooses to leave the business. It can also help the business if an owner declares bankruptcy or gets a divorce.
In the Event of an Owner’s Death the Buy-Sell Avoids Problems with Deceased Owner’s Estate
If the company is owned equally by four parties, using the names Joe, Bill, Sandy, and Linda for example, and they all work full-time contributing to the company’s growth, if Linda dies unexpectedly, her heirs will receive her shares. A predetermined formula agreed to by the owners can set the buyout price, which the other owners will pay to Linda’s heirs. Life insurance can provide the funds the other owners might need to make the payments to Linda’s heirs.
Having a Prenuptial Agreement and Buy-Sell Agreements Is The Way to Go
The prudent business owner should include a prenuptial agreement in their business planning. The prenuptial agreement should make clear that the ownership interest in the business is the owner’s separate property and not subject to community property laws or other claims by the spouse. Few people have a prenup; therefore, it is critical to create a buy-sell agreement.
Dealing with Divorce
As mentioned above, a prenuptial agreement can make a divorce less horrible (Not nice but less horrible). Often, one of the most hotly contested issues in a divorce is the value of a small business. Business valuation is important because community property law holds that both parties have an equitable interest in a business run by one or both spouses. This commonly results in the parties hiring forensic accountants to value the business. These differing opinions on value are then set out in a trial. Whoever wins the expense of the trial greatly diminishes the community assets which results in less for both parties. The divorce process can impede the business. Worse, if there is no Buy-Sell Agreement the spouse of the owner may receive an ownership interest. No one wants to try to work together with two ex-spouses.
The problems can be decreased somewhat if the Buy-Sell Agreement for the owners of the business states that share transfers are restricted in some manner by the Buy-Sell Agreement. The non-divorcing owners of the company itself might be given the right of first refusal to purchase the divorcing owner’s shares with a price or a method of price calculation incorporated into the agreement. In this way the divorcing spouse receives cash instead of shares.
Disability of One of the Owners
If one of the owners suffers a serious illness and cannot work, the Buy-Sell Agreement can spell out how disability will be determined—whether the ill owner will receive a salary and how a buyout, if necessary, will be structured. It is a very good idea for the owners to have disability insurance. This insurance can provide the funds necessary for salaries and buy outs when taking the money out of the business would be detrimental.
Sometimes one owner wishes to retire or leave the business to pursue other interests. A Buy-Sell Agreement can set out how an owner is compensated for their interest in the company. Payments are often made over an extended time period and the Buy-Sell Agreement can distinguish between retirement and a departure to pursue something else. The Buy-Sell Agreement could discount the purchase price if the owner leaves after only a few years and can delay the payout until a certain time if all owners agreed.
Bankruptcy of One of the Owners
If one of the owners files for personal bankruptcy the Buy-Sell Agreement can set a procedure whereby the bankrupt owner’s creditors receive cash instead of interests in the business.