Published in the Union Leader
Q. I will be entering into a
new business venture with several other individuals. What happens to an owner’s
interests in the business if he or she dies, retires, or wants to sell that
interest, or if a majority decide that an owner must be expelled?
A. The law provides numerous avenues that enable two or more individuals to start a business together while minimizing their personal risk arising out of claims against the business. Unfortunately, the law provides little guidance to address situations in which one of those individuals wishes no longer to be an owner, or when a majority of owners wish to expel another owner. This lack of guidance makes reaching agreement on when and how ownership transfers take place vitally important.
At the outset of a new venture, owners should discuss and agree in writing on the following:
1. Under what circumstances will an owner have an option or obligation to sell his or her ownership interest?
2. If an ownership interest is to be sold, how will the purchase price be determined? 3. After the purchase price is determined, where will the money come from to pay it?
These can be vexing questions, and the discussion of them can sometimes lead to surprisingly divergent opinions between co-owners who thought they shared a common perspective. The discussion of, and hopefully ultimate agreement on, these questions will help co-owners to recognize which goals and viewpoints they share and which they do not.
Circumstances of transfer
Circumstances to consider as “trigger” events for ownership transfer includes death, disability, retirement and pre-retirement age voluntary or involuntary departure from employment from the business.
A critical initial question is whether ownership will be confined to individuals employed by the business. If the owners decide that all owners must also be employees, then they should consider whether the circumstances of employment termination will affect either the purchase price to be paid or the period of time over which a departing owner will be paid. Contrast, for example, retirement at age 65 with involuntary termination for embezzlement from the business’ coffers.
Determining the purchase price
The purchase price that will apply to an ownership transfer can be expressed as an objectively determinable amount or formula (e.g., book value or a multiple of the weighted average of earnings over a period of years), or as fair market value to be calculated by a disinterested professional at the time a sale event occurs.
Whatever the owners choose, the critical point is to agree in advance how the purchase price will be calculated. If they wait until a transfer triggering event occurs, disagreement will often result because the seller will seek to maximize the purchase price while the buyer will seek to minimize it.
Paying the former owner (or his or her estate)
In addition to determining how much a departing owner will be paid, the remaining owners need to determine how to pay him or her without severe economic risk to the business or themselves. In most cases, life and disability insurance policies on each owner are advisable.
For retirement and pre-retirement departures, a promissory note, payable over a number of years, is the only realistic option. The number of years can be on a sliding scale, depending on the size of the purchase price. Whatever the owners choose, they need to be ready at any time to be able to make payments while safeguarding the business’ finances.
Conclusions
For the co-owner of a new business, planning for the departure of one of them can never start too soon. Tough issues will have to be tackled, but tackling them will lead to a better understanding among owners and help the business to weather ownership transitions smoothly.
Tony Delyani can be reached at tony.delyani@mclane.com.
Know the Law is a bi-weekly column sponsored by The McLane Law Firm.
We invite your questions of business law. Questions and ideas for future columns should be addressed to: Know the Law, The McLane Law Firm, P.O. Box 888, Manchester, NH 03101 or emailed to knowthelaw@mclane.com. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.