Builders and Contractors Exchange
Weekly Bulletin: 13 Jun 2005
Make Sure Your Business "Succeeds"
- Part 2: Succession Planning For Voluntary Departures
By: Christopher Ambrosio
A previous article on this subject dealt with the issues surrounding a small business owner's involuntary departure from a business, i.e. through death or disability. This article will discuss voluntary departures, such as when an owner decides to retire or wants to leave the business to pursue other opportunities.
A voluntary departure creates a dilemma for the departing owner and for the remaining owners. Because the ownership interests in small businesses typically are not publicly traded, the owner cannot simply sell his or her stock (or other equity interest) on an open exchange. Rather, the owner, either himself or through a broker, must find an interested buyer. The remaining owners, in turn, generally do not want the departing owner to retain control or voting rights in the business, nor do they want an outsider to assume those rights.
One solution is to have an agreement among all the current owners that provides for a right of first refusal in the event an owner wants to sell his or her ownership interest. The departing owner cannot sell to an outsider without first making the same offer to the company or the other owners. If the offer is not accepted, the departing owner is free to sell it to the outsider. Another solution is to have a mandatory buy/sell arrangement in which the company or remaining owners are required to buy the departing owner's interest at a predetermined price, either a fixed amount or mathematical formula, or at a price that is determined by a specified process (e.g. by one or more accountants providing a valuation).
Typically, if there are multiple owners, each remaining owner is entitled to purchase his or her proportionate share of the departing owner's interest. Complications can arise if one or more remaining owners does not want to participate in the buyout. In a mandatory buyout arrangement, the owners who do not want to participate will either owe a debt to the company in the amount of the purchase price for the shares they should have purchased, or will have their interests in the company proportionately reduced. In an optional buyout arrangement, if any owner fails to purchase the full amount to which he or she is entitled, the remaining owners are given an opportunity to buy more than their proportionate share until the entire interest is purchased. These are just the basic outlines of a few typical arrangements. Depending on the creativity of the owners and the size of the business, agreements of much greater complexity can be drafted. Because these arrangements can have long-range legal and tax consequences, they should be discussed, negotiated, and drafted with great care, preferably with the advice of an experienced business attorney.
Questions?
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This article is meant to bring awareness to this topic and is not intended to be used as legal advice.