6 best practices for an exit
How to plan for a co-owner’s unexpected departure from the business
Unexpected events like the sudden death, disability or unplanned retirement of a co-owner can be incredibly stressful and frequently negatively impact a company’s business. In addition to the emotional and practical difficulties, these events can also cause significant legal and financial uncertainty in the absence of proper planning.
Here are six best practices business owners should follow to avoid these uncertainties:
1. Make major decisions ahead of time: Every business owner should decide in advance what he or she wants to happen to the business in the event that he or she or a co-owner is no longer in a position to continue owning and/or operating that business. Making and properly documenting a decision ahead of time will provide a clear course of action for all interested parties and prevent the disagreements and controversies that can negatively impact your company’s operations and reduce its value.
2. Get down to specifics: Consider the common situation in which business partners agree that each will have the right to buy out the other in the event that the other dies, becomes disabled or decides to retire. This basic agreement in principal is rife for potential disagreements between the partners and/or the other interested parties without specifics regarding issues such as how the departing partner’s interest will be valued. Avoid roadblocks by insisting on nailing down as many details as possible when the basic agreement is being negotiated and documented.
3. Make buyouts workable: Ideally, a buyout should promptly provide the departing partner (or her estate) with the fair value of her interest without financially burdening the remaining partners to the point of negatively impacting the business. Agreeing on a method for determining the valuation of the business and making a portion of the buyout price payable by promissory note paid out at a low interest rate over three to five years often helps achieve this balance.
4. Consider a ‘shootout’ provision to avoid disputes: Partners who jointly own and operate a business can unfortunately find themselves in a position where they are unable to continue working together. Without any advance planning, these situations can be highly contentious and put a major strain on a business. So-called “shootout” provisions in owner agreements are a common mechanism for imposing structure on a business breakup and thereby avoiding potentially contentious disputes.
Under a shootout provision, one partner names a price at which he will either buy out the other partner or be bought out by the other partner. The “shootout” generally results in a fair price, since the partner making the offer does not know whether he will be the buyer or the seller.
While shootouts are an efficient way to conduct a business divorce, they can create their own issues without proper drafting. For example, a shootout initiated by a more knowledgeable/involved partner could produce an unfair result for a less knowledgeable/involved partner if the agreement does not require that the partner receiving the shootout offer have sufficient time and access to financial information to make an informed decision.
5. Call the accountant: Transactions surrounding owner buyouts or retirements can create very complicated tax issues. This is particularly true if the business is owned through a partnership or a limited liability company taxed as a partnership. Unexpected tax consequences can often warp the intended economic consequences of a partner buyout or retirement.
For example, the IRS may require a departing partner who receives deferred payments for the sale or redemption of her interest in a company to pay flow-through tax on income generated by the company even though she is no longer an owner of the company. Business owners should engage an accountant or tax counsel at the planning stage to help identify potential tax issues and implement strategies to preserve the intended economics of an owner buyout or retirement.
6. Maintain accurate books and records: Maintaining complete and accurate books and records will greatly reduce the chances of a dispute surrounding the transition of an owner out of a business. Good books will give everyone involved a better picture of the value of a departing owner’s interest in the business and will greatly assist the accountant in determining the tax consequences of the transaction for the departing partner and the company.
Attorney John Goodlander is a member of the business practice group at Shaheen & Gordon, with offices in New Hampshire and Maine.