Transferring the Business to the Next Generation: 13 Questions to Discuss with your Children to Avoid a Failed Succession Plan
By: Attorney James A. Spella, Schloemer Law Firm, S.C. and Attorney Amanda N. Follett, Schloemer Law Firm, S.C.
If you are considering transferring your business to the next generation, there are 13 questions you must discuss with your children before you begin. Careful consideration and deliberation is important for a successful plan. Without such planning, tragic consequences can follow: family relationships become strained or non-existent, the business can fail, employees may flee, children may become shackled to the business with little to no knowledge of how to manage it properly, and parents may lose the opportunity to sell to an outside party at a premium value.
A good place to start is having a conversation with your trusted advisors, such as your accountant and your attorney, to discuss what you want the process to look like, how you want it done, and what to expect. Meeting with trusted advisors in one meeting helps simplify the discussion for you and gets everyone on the same page. After discussing with your advisors, have a family meeting and have an open and honest conversation.
There are 7 Initial Questions we recommend asking yourself to start the process, which were discussed in last month’s blog, available here: Transferring the Business to the Next Generation: 7 Initial Questions to Ask Yourself to Start the Process
Once you consider these questions, if you still decide to transfer the business to the next generation, the next step is to form a written agreement to memorialize the plan. Having a written agreement is essential when forming a business relationship, especially among family members. The agreement is also critical, for example, if you decide to turn course and seek a sale to a third party rather than a transfer to the next generation. Here are the 13 Questions we recommend every family discuss before they begin the transfer:
- Should the parents have a right to buy-back shares transferred (by sale or gift) to children under any circumstances?
If parents have the right to buy-back shares, the next question would be to determine how the purchase price would be calculated. Either a formula or an appraisal can be used.
The next question then would be how the children would pay the purchase price. Here the options are immediate payment, a Promissory Note, or a combination of the two.
- Should any of your children have a right to buy-out the others?
If any children have a right to buy-out other children, the first question then, once again, is how to calculate the purchase price, whether it be by a formula or to require an appraisal.
Once again, the next question then would be how the children would pay the purchase price, whether it be an immediate payment, a Promissory Note, or a combination of the two.
- Should shares be held in a Voting Trust?
A Voting Trust is an arrangement where shares in a company of one or more shareholders are held in a trust, so that the trustee can vote the shares. This allows for a transfer of ownership, but not a transfer of voting rights.
- Should there be restrictions on who a Shareholder can transfer shares to?
Often times, a parent will impose restrictions on who a child can transfer shares to in the future. For example, there may be restrictions on who a Shareholder transfer their shares (by gift or sale during lifetime or at death) to, such as to parents, siblings, lineal descendants, spouses, or others?
Another related questions is whether the answer the same for all Shareholders (parents and children). Parents may be permitted more flexibility in who they can transfer shares to. Some children may have different restrictions than others, depending on their situation.
- Should Shareholders be employees of the Corporation?
If Shareholders are to be employees, it may be prudent to put in place employment agreements to set forth the expectations.
A Shareholders Agreement can also address the situation where a Shareholder ceases to be an employee (i.e., a Shareholder is fired or quits). Employment termination may trigger a buy-out of their shares by other shareholders.
- Should any Shareholder have the right to buy out the other Shareholder(s) in certain circumstances or at any time?
There may be situations where a Shareholder should have the right to buy-out other Shareholders. Examples of triggering events can include death, disability, divorce, and termination of employment.
This triggers a few follow up questions. Shareholders will need to determine (1) if the purchase is optional or mandatory; (2) how the purchase price will be calculated; and (3) how the purchase price will be paid (i.e., immediately, Promissory Note, or combination).
- What should specifically happen upon the death of a Shareholder?
The death of a shareholder is a major event and a possibility that needs to be discussed.
As an initial inquiry, you could consider if shares should be transferred to children or a spouse.
If not, the question is if the shares should be purchased by the surviving Shareholder(s). In a buy-out, the purchase can be either an optional buyout, or a mandatory buyout. If a buy-out is contemplated, life insurance should also be considered to ensure the availability of adequate funds. Purchase price and payment also need to be considered.
- What happens if a Shareholder decides to voluntarily withdraw, i.e., leave the Company?
Another unpleasant event that needs to be considered is if a Shareholder wishes to leave.
In this case, can the Shareholder sell to an outsider? Typically, the answer is no. The remaining shareholders either have a first option to purchase the departing shareholder’s interest, or they are required to do so.
- Should the Shareholders have a first option to purchase each other’s shares?
Often, an agreement will provide Shareholders with a first option to purchase shares.
If parents retain shares, they often have a first option to purchase a child’s shares, before other children. Purchase price and payment terms need to be determined.
- Can any Shareholder (parents or children) force the sale of the Company to an outside purchaser?
This poses an interesting question, and the answer varies depending on the situation. Parents may wish to retain the right to force a sale as long as they own an interest; this may be useful if the right opportunity presents, or if the succession plan is not going as anticipated.
- How are decisions made regarding management and control?
IN the are of management and control, there is often a split between day-to-day decision making, and major decisions. While one person may be responsible for day-to-day decision making, other decisions often require consent of: (i) a majority (51%) of Shareholders, (ii) a supermajority (greater than 51%) consent of Shareholders, or (iii) unanimous consent. Note, however, unanimous consent is usually avoided, as this would permit one “hold-out” Shareholder to essentially veto decisions.
- Are there situations that could create a deadlock?
If there are situations where a deadlock may arise and the directors cannot reach agreement, how should the deadlock be resolved? This is more common if there will be two Shareholders who are each 50/50 owners. Options in that case include: third party deciding vote, forced arbitration, forced sale, or a wind up and liquidation of the company.
- If a Shareholder leaves, are they subject to any restrictive covenants?
Often times, if a Shareholder leaves and is bought out, they may be subject to restrictive covenants, including: (i) Non-competition in the industry, (ii) Non-solicitation of employees, and (iii) Non-solicitation of customers.
These questions are intended to get you and your family started in your discussions. Next month’s blog will delve into depth on these questions and key provisions in an Ownership Restriction Agreement.
If you have any questions, would like to begin the discussion, or can’t wait for next month’s blog, please contact this article’s authors, Attorney James A. Spella or Amanda N. Follett, or one of our estate planning attorneys.
Originally published: October 6, 2020.
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Disclaimer: The information contained in this post is for general informational purposes only and is not legal advice. Due to the rapidly changing nature of law, Schloemer Law Firm makes no warranty or guarantee concerning the accuracy or completeness of this content. You should consult with an attorney to review the current status of the law and how it applies to your unique circumstances before deciding to take—or refrain from taking—any action. If you need legal guidance, please contact us at 262-334-3471 or [email protected]