Operating a successful company without a proper succession plan in place is akin to walking a tightrope without a safety net. Your business, your livelihood, and your legacy could be in jeopardy of a sudden, drastic change of ownership, direction, and values.
Many possible risks can threaten your ownership, control, and continuation of your business. These risks can be intentionally or unintentionally caused by you or outside factors.
Small businesses without succession plans, upon a change of ownership, are likely to suffer disputes over proper management & control, loss of direction or mission, loss of leadership with requisite business experience and competence, lack of communication, and could get caught in time and asset-consuming, disputed probate proceedings.
A Buy-Sell Agreement is a specific type of contract among business owners that pertains to the transfer (or limitation on transfer) of ownership interests. The buy-sell agreement provides the owners the right (or obligation) to transfer ownership interests upon the happening of numerous possible triggering events, and creates a funding mechanism for such transfer.
Triggering Events include:
Death of an owner* – reduces uncertainty of how death of an owner will affect the entity and lays out a succession order & plan or the founder’s Succession Statement.
Disability or incapacity of owners *
Divorce – can prevent transfer of interest to owner’s spouse in divorce, resulting in a spouse becoming a partner.
Lifetime transfers of ownership interests to individuals outside of intended shareholders (includes gifts and sales by owners to unintended 3rd parties).
Irreconcilable differences – Estrangement Clause can provide an exit strategy if the owners cannot, after reasonable efforts, resolve differences of opinion.
Bankruptcy or insolvency of company and owners
Retirement or cessation of employment of an owner*
* Important when the owners are expected to contribute to the management and operation of the business.
In the context of family owned, closely held businesses, buy-sell agreements can be used to address the common concerns of: a) providing for surviving spouses after the primary breadwinner dies or becomes incapacitated; b) equitable and controlled buy-out of family members not directly involved and working in the business; and c) the difficulties of management by more than one child of the current owner.
The most common provision in a buy-sell agreement creates a restriction on the ability of an owner to transfer any part of her business interest to a new owner. An example of such a restriction would be a family-owned business that desires to restrict ownership of the company to direct family members. It is important, however, to note that restricting permissible transferees may impact the value of the business interest because the pool of potential buyers is smaller than it would have been without such restrictions.