The old adage “Failing to plan is planning to fail” can easily be applied to owning a business. Business owners need to be prepared for the many contingencies that come up during the lifecycle of their business. Much like a person’s estate plan, proper planning should be taken to ensure as little disruption as possible to the company’s operations should a life changing event occur to one of the owners.
Savvy entrepreneurs choose to enter into what is commonly referred to as a Buy-Sell Agreement, but similar terms can also be found in corporate Shareholder Agreements or a limited liability company’s Operating Agreement. These agreements can be used to address the many contingencies co-owners of a business may face. Three of the most significant contingencies to plan for are the three Ds: Death, Disability, and Divorce.
The equity a person holds in a company is personal property and as personal property the equity will fall into the person’s estate upon their death. That may seem like a logical result, but without proper planning the company will be co-owned by the deceased owner’s estate, and presumably the deceased owner’s family. For the business and remaining owners, this may result in disruption, distrust, and ultimately a dispute between owners. The new owners may not have the knowledge, desire, or time to manage the company. Conversely, they may indeed be ready, willing, and able to take over the company and push other owners to the side.
The total disability of an owner can also have negative consequences for the business. Should a business owner lose the ability to work or be unable to contribute to the business endeavor, the business may need to seek an alternative candidate to replace the loss of productivity. Additionally, the disabled owner may want their interest in the company to be liquidated to grant them the financial flexibility to cope with the challenges a disability presents.
Divorce may not seem like it should impact a business, but since the owner’s interest in the company is personal property, it could also be deemed marital property by a probate court. In the division of marital assets, a former spouse could argue they are entitled to a portion of the divorcing owner’s equity in the business. Should the probate court agree, the court may award the former spouse an interest in the company. Much like in the event of a death, the remaining owners may now be in business with someone they never contemplated running a business with.
Buy-Sell Agreements can address many of the contingencies business owners may face but Buy-Sell Agreements are not a one size fits all. The desired outcome of the three Ds and other contingencies will depend on the specific dynamics of the business relationships and the goal of the company. The terms of a Buy-Sell Agreement should be tailored to meet the needs of the owners, which may change over time. Entering into a Buy-Sell Agreement should be a top priority of a new business owner, but seasoned business owners should also revisit existing agreements as the dynamics of the ownership changes.
