Those of us who are business owners spend our waking hours focusing on ways to grow our business and ensure its ongoing success. But because none of us is immortal, part of our planning must include considering the mechanism by which we will exit the business, hopefully receiving good value for what we have built. In this article we draw on examples to highlight some of the key issues we should have in mind when planning our exit strategy in business.
Many of our clients do not fully appreciate the need to have a clear and detailed business succession plan in place. While sole business owners can often get away with no formal structure in place, in situations where you have 2 or more business partners it is vitally important to have a clearly set out strategy for what happens if one of them ceases being involved in the business, otherwise there can be unfortunate results.
To highlight this, we have included some examples of issues that have arisen in the past, and how they could have been avoided with a documented business succession strategy in place:
Case Study 1:
2 individuals are 50/50 owners of a corporation. One of them passed away and as a result his shares passed to his next of kin. While the next of kin took no role in managing the business they retained their rights to receive dividends. It took extended negotiations, and a payment which was arguably above market value, for the remaining owner to obtain full ownership of the company;
By entering into a buy/sell agreement, under which there is an automatic transfer of shares on death (often funded by insurance), the surviving business owner would have automatically received the shares on his business partner’s death, with the next of kin being compensated in accordance with a valuation method agreed in advance.
Case Study 2:
2 individuals are 50/50 owners of a corporation. One of them ceases taking an active role in managing and running the business. As shareholders generally have no positive obligations regarding running the company, one owner is left doing the heavy lifting, while the other retains the right to dividends and/or capital on the sale of the company.
By putting in place a shareholder’s agreement, stating the minimum performance requirements, the active business owner can require the other to help in the business or, failing such, force the sale of their shares, often at a discounted rate.
Case Study 3:
3 individuals are running a business as a partnership. One of them passes away. Under the Partnership Act 1892 NSW (The Act) the death of one partner automatically dissolves the partnership. Now, while dealing with his grief, the surviving partners must also navigate the dissolution of the business.
The Act is subject to any agreement of the partners. Any properly drafted partnership agreement will cover what happens in the event of the death of one of the partners. This may involve the surviving partners taking sole responsibility for the business, or, similarly to the first point, the surviving partner making a payment to the deceased partner’s next of kin in exchange for the partnership interest.
What is clear from the above is that it is important to plan for these eventualities early, rather than trying to navigate a difficult situation, in circumstances where not everyone may be acting in a collegial manner.
If you have any questions, or would like to discuss your business succession needs, please contact our Commercial Law team.