Follow Dallas Linkedin
Email Dallas Email
Financial
Jun 30, 2017

Business Continuity Planning For Co-Owners

Sponsored Content provided by Dallas Romanowski - Managing Partner, Cornerstone Business Advisors

Imagine that on the eve of your wedding, you make a plan to divorce your spouse, on friendly terms, in about 15 years. During those 15 years, you agree to work diligently and successfully to build a business.
 
On the preordained day that your marriage ends, you announce you are willing to give your soon-to-be ex-spouse one-half of your company’s business value in cash. Additionally, you let your ex-spouse value your company, because those are the terms of the agreement the two of you signed a year after you were married.
 
Though this scenario may seem ridiculous, you may have done something quite similar in your business with your co-owners.
Few owners begin working together with an expectation of future acrimony, much less litigation. Fewer still give thought to one day leaving the business - even on friendly terms. Indeed, most exits are not precipitated by a disagreement among co-owners; instead, owners leave for a variety of reasons and simply want to do so with their share of business value.
 
Remember: One day, you will leave your business.
 
Over time, in business, as in marriage, partners can grow apart. We’ve all witnessed the resentments, discord and wastefulness of a friend’s needlessly nasty divorce. Business divorces can be equally unpleasant, but with an added twist - owners may be unable to leave the business, or force a partner to leave, without appropriate tax and legal planning.
When an owner or co-owner wants out, what will happen? Chances are that when owners and co-owners turn to the company’s buy-sell agreement, they will find that it is woefully out of date. They may also find it controls the terms of their exits from their businesses, not only upon death but also during the owner’s lifetime.
If you haven’t looked over your company’s buy-sell agreement since you signed it, dust it off and check at least four of these key provisions:
 
Lifetime and death transfers of ownership
 

  • When must an owner sell or offer to sell?
 
  • When must a co-owner (or the company) buy, and when does the co-owner or company have the option to buy?
 
  • How will the value of the company and the value of a departing owner’s interest be determined?
 
  • Does the agreement mandate the use of an independently determined fair market value at the time of transfer? If not, the valuation will favor either the buyer or seller. It will not treat co-owners evenhandedly.
 
  • What are the terms (length, down payment, interest and guarantees) of the buyout?
 
We generally assume that buy-sell agreements control the transfer of an owner’s interest when he or she dies or becomes disabled. However, they usually do much more, and if owners don’t appreciate how much more, disaster looms.
 
Consider the following scenario: At his annual physical, Steve Hughes complained he was bone-tired. After a battery of tests, Steve’s doctor observed that, while there was nothing physically amiss, Steve did seem depressed. After some introspection, Steve was able to articulate that he had no interest in continuing as a partner in his successful CPA firm. Like many owners, Steve had lost the passion and commitment to the business that still stoked his younger co-owners. He decided to sell out before his partners demanded it.
 
Steve broke the news of his departure to his two partners and noted that their buy-sell agreement controlled only a buyout at death and an option for the company to buy Steve’s stock if he were to sell it to a third party. Attempting to sell a partial interest to a third party is always a difficult proposition, but economic challenges made that course of action impossible.
 
Steve and his partners were left in a classic dilemma - the remaining shareholders wanted to purchase the departing shareholder’s interest so future stock appreciation - due solely to their efforts - would be fully available to them. Conversely, because the profits of a closely held corporation are either accumulated by the company or distributed to the active shareholders in the form of salaries, bonuses and other perks, the departing shareholder (now an inactive owner) rarely receives significant income in the form of distributions or dividends.
Naturally, Steve wanted and needed maximum value for his interest, while his co-owners were convinced the company’s cash flow could not support Steve’s buyout.
 
In light of this scenario, owners must examine their business continuity agreements immediately. If the owner is the one leaving, is the agreement as fair as it would be if the owner were the one left behind?
When you sit across the bargaining table from your business partner(s) for the first time, you will want that table set with a fair valuation method, a thoughtfully designed lifetime buyout provision (that may well reduce the cash flow required for a buyout by 20 to 30 percent), and manageable payment provisions. Since it is exceedingly difficult to design these provisions when the buyer and seller are at the bargaining table, owners should agree to and document the valuation, cash flow and tax and payment provisions long before potential discord and differences of outlook arise.
 
Your first step toward avoiding the problems described in this article is to conduct a thorough review of your business continuity agreement, and we are happy to help you do so. If you would like a more extensive checklist and additional information about this most important of all business documents, please contact us.

© Copyright 2017 Business Enterprise Institute, Inc. All Rights Reserved
 
As a member of the Business Enterprise Institute (BEI), Cornerstone Business Advisors is an authorized distributor of BEI’s content and Exit Planning Tools.

The Cornerstone team includes former C-Level executives, successful entrepreneurs and advisers who offer unmatched experience in delivering advanced, custom-tailored, results-oriented solutions for business leaders. We developed the Performance Culture System™ to help clients implement best practices and drive high performance throughout their organization. For more information, visit www.launchgrowexit.com, call (910) 681-1420 or email [email protected].
 
 

Other Posts from Dallas Romanowski

Bizjournalblockad
Ico insights

INSIGHTS

SPONSORS' CONTENT
Webilm julieformal kellystarbuckcom mg 5471

Airport Amenities to Enjoy, On the Fly

Julie Wilsey - Wilmington International Airport
Geofflosee300x300 10221511305

Got Flood Insurance? Get That Proof of Loss Form in Quickly!

Geoffrey Losee - Rountree Losee LLP
Chadwoutersheadshot

Changes Coming to Sales Tax on Internet Sales

Chad Wouters - Earney & Company, LLP

Trending News

Open For Business: New Announcements (Sept. 19)

Johanna Cano - Sep 19, 2018

Power Outages Remain In New Hanover County

Christina Haley O'Neal - Sep 20, 2018

Tips On What To Do Now For Storm Damage

Vicky Janowski - Sep 19, 2018

Open For Business: New Announcements (Sept. 20)

Johanna Cano - Sep 20, 2018

Downtown Recovery Ongoing, Flooding Still An Issue

Cece Nunn and Christina Haley O'Neal - Sep 19, 2018

In The Current Issue

State Releases Visitor Spending Data

Visitor spending increased in Pender County for 2017, with a growth rate that outpaced Brunswick and New Hanover counties, and even the stat...


Investing In Affordable Housing

A recent high-dollar deal in Wilmington represents not only a little more affordable housing in the city but also a good investment for the...


Love, Lydia Bakery Moves In

Lydia Clopton opened Love, Lydia in July at 1502 South Third St. The location was previously a home that was remodeled into the bakery....

Book On Business

The 2018 WilmingtonBiz: Book on Business is an annual publication showcasing the Wilmington region as a center of business.

Order Your Copy Today!


Galleries

Videos

2018 Power Breakfast - Dishing on the Restaurant Biz
2018 WilmingtonBiz Expo - Keynote Lunch with Eric Dinenberg, Rouse Properties
2017 Health Care Heroes