Small business owners are a critical segment of our economy, and they are a foundation for future growth. As the baby boomer generation grows older, it is estimated that close to 60‐80% of small businesses will transfer ownership over the next ten years. Additionally, many of these business owners have close to 75% of their net worth embedded in the business. So, these business owners have a critical need to preserve the value of their business and ensure a smooth transition of their business to future owners.
Unfortunately, many of these business owners are very, very busy with their day‐to‐day business operations. As a result, it is difficult for them to prioritize time for proper succession planning. It has been estimated that 80% of business owners have no succession plan.
This creates tremendous risk for business owners, and an unexpected death or disability will cause significant damage to the business value and their family’s future.
But death and disability are not the only unexpected events that could damage the value of the business. Here are a few additional events: What happens when a shareholder decides to leave the business? What if a shareholder declares personal bankruptcy and his ownership shares become subject to the bankruptcy court? What if a shareholder goes through a divorce and as part of the property settlement her ex‐husband becomes your new shareholder?
These are all examples of “trigger events” business owners need to plan around, and then they can control their own destiny.
A corporate shareholders agreement, or an operating agreement for an LLC, provides business owners the ability to control their destiny and preserve the value of the corporation. This agreement also details the shareholders agreed plan on what should happen if one of the many trigger events occur in the life of the corporation.
Succession planning, or planning for the death of a shareholder, is the most discussed trigger event, but the shareholder agreement covers so many more trigger events.
In addition to documenting these agreed plans, the shareholders agreement defines how a closely‐held corporation is valued. The ultimate value is what a willing buyer will pay for a share of the corporation, but closely‐held corporations do not have many willing buyers for the business.
As a result, the shareholders agreement defines a valuation measure and an ongoing process to update it. Therefore, when a trigger event occurs an equitable, agreed value is provided for the shares.
No shareholders agreement is complete without a plan for funding the exchange between shareholders.
For instance, how is the corporation planning to buy the shares from the surviving spouse of a deceased shareholder? Life insurance is often used in this situation.
Other common funding questions include what type of buyout plan should be expected when a shareholder sells their shares due to a pending divorce or bankruptcy? Can they buy the shares back later? All of these funding decisions are specified for the corresponding trigger events within the shareholders agreement.
The wise small business owners will quickly realize they really need to have a shareholders agreement in place. Otherwise these trigger events can dramatically affect the value of their business and their family’s future. Call us today at 501-221-7776 to work on your small business today.
Note: This post is credited to ElderCounsel.