As Chris Corrigan so aptly stated, “You can never over-prepare in business!” Yet, we know, from strategic plans to budget plans and marketing plans to staffing plans, business owners find it difficult to fit it all in. Now I raise the issue of succession plans… another one of those plans that doesn’t seem critical today; but, in the grand scheme of things, it is a critical factor in business continuity and longevity. The topic is most commonly raised in connection with an owner’s retirement; but it also applies in situations of death, disability, and other withdrawals of owners or executives from the company.
With closely held businesses, the succession issues that affect ownership also affect management because the same people typically hold both positions. The close-knit group find it difficult to distinguish between their ownership in the company and their roles as employees of the business. For this reason, a critical protection for the company is often missed: You cannot fire an owner but you can fire an employee. If an owner fails to perform his or her duties, the owner can be fired as an employee but remains an owner with a right to participate in the profits and losses of the business. For many businesses, this just doesn’t seem “fair.” If properly addressed up front, though, “fairness” can be built into the formal relationships among the parties.
In most closely held and family owned businesses, the “formal relationship among the parties” I refer to above is an agreement between owners (usually an “Operating Agreement” for LLCs and a “Shareholders’ Agreement” for corporations). This agreement should spell out under what circumstances an ownership buyout may be triggered. These circumstances include both involuntary and voluntary withdrawals of owners from the business. The termination of employment would be a typical trigger of a mandatory or optional buyout by the company or the other owners. This buyout gives the company power to determine whether the terminated person remains an owner despite his or her employment termination. Other involuntary departures that may trigger buyout provisions are death, disability, and bankruptcy. Voluntary departures must also be considered in these agreements. Often an owner elects or is forced to cease participation in the business activities due to retirement or other reasons. The agreements should address whether the company or other owners have the right to purchase the interest of the departing owner in a voluntary departure situation. In all cases, the agreement should specify the buyout terms.
The process of thinking through these scenarios and terms offer the business owners an opportunity to consider the critical people in the business and the confidence that the business is in good hands in the event of a planned or sudden departure of one or more owners.