Planning your exit strategy early on in the life of your business is an important, albeit unsavory task for you and your business partners. This is typically and appropriately done through the use of a Buy-Sell Agreement, which is addressed in further detail here. To recap, Buy-Sells can be excellent tools for planning for the death, disability, disagreement, divorce, and/or retirement of any of the owners of your business. By providing for the process beforehand (while everyone is still able to reach an agreement), much of the emotion and uncertainty that typically accompanies a business partner’s exit is avoided.
But what if the Buy-Sell fails to address certain triggering events? For instance, a recent client and his siblings were second-generation owners of the family business. The business had a Buy-Sell in place, which provided for what to do in several scenarios, such as death, disability, divorce, incapacity, etc. For a shareholder’s voluntary exit, however, it only covered the process of selling to a third party. But the client just wanted out, and selling to a third party was undesirable for the client and the business. Despite a history of the siblings not getting along, the Buy-Sell failed to provide for how to handle a shareholder’s exit in the case of disagreement.
What’s a good option for planning for disagreement between owners?
Disagreement between business partners is the hardest scenario to plan for, especially at the beginning of the life of the business. No one wants to make detailed plans for a falling out while still in the honeymoon stage. Business owners may fear that such planning will fast-track them into a disagreement and a partner’s inevitable exit. But those who follow through with this crucial exercise will attest to the peace of mind it brings among business partners.
The option that would have best suited the client in the above scenario is the use of a Forced Buy Out provision in the Buy-Sell. Such a provision lays out the process by which either the business or its owners must purchase the exiting shareholder’s interest when he or she no longer wishes to be part of the business. Without such a provision, majority shareholders owe no general duty to buy out a minority shareholder’s interest on demand. Absent a forced buy-out, the exiting shareholder must attempt to negotiate the sale of his or her interest to the other shareholders, which may prove difficult and contentious if the relationship has already deteriorated to the point of driving the minority shareholder to leave the business.
If the negotiations fall apart, as they often do in such situations, then the minority shareholder’s only options may be to (i) become a passive owner, subject to the distribution/dividend decisions of the majority; (ii) attempt to sell to a third party, which is unlikely given the value of a minority interest in a closely-held or family-owned business is less than the proportional ownership percentage of the business’s value; or (iii) pursue a shareholder oppression suit, which litigation is very fact-dependent, yields uncertain results, and may cost more than the exiting-shareholder’s interest is worth.
None of the above are great options. If the family had worked together at the beginning to provide for disagreement and a minority shareholder’s voluntary exit, then the process would have been faster and cheaper (for the business and the client), and family relationships may have been preserved. Instead, negotiations were drawn out, spiteful, and expensive. A forced buy-out provision in the Buy-Sell, in this instance, would have protected both parties.
When considering whether a forced buy-out is the right move for your business, ask:
- Are any of the owners not essential for the survival of the business? If so, it may be worth it to allow that owner to remain a passive owner, which may be desirable for the minority owner (think dividends with no contribution).
- What harm can an unhappy minority shareholder do to the business? A successful business needs motivated individuals at the helm. If a shareholder participating in the management of the company is being mistreated and can’t get out, motivation falls, and profitability falls with it. It may be worth it to buy out that shareholder rather than watch the business deteriorate by forcing him or her to hang on.
- What financial planning must the business engage in now to fund a forced buy-out down the road? If a business fails to save enough cash to buy out the minority shareholder, and if the minority shareholder succeeds in a shareholder oppression suit, the business may be dissolved by court order to pay the oppressed shareholder off.
No one goes into business with an enemy, and disputes between shareholders are usually unforeseen at the outset of the business relationship. Protect your business, and your interests therein before an unforeseen disagreement makes it impossible. Contact our Sioux City law firm, Sioux Falls law firm, or Omaha law firm today to help you with the transition ahead.
DISCLAIMER: The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. By visiting this website, blog, or post you understand that there is no