Many businesses with more than one owner operate for a long time. If one of the owners decides to check out, however, then all of the gaps that existed during your partnership will become exposed and possibly cause damage to someone.
The situation may be different for each type of check out. One can check out of a business by dying, becoming totally disabled or simply looking to move on or retire. In all cases, your small business needs a current operating agreement that clearly spells out the terms of what happens if any of the above occur. Because some of these events are unplanned and frequently sudden, the agreements that you create should be reviewed every year to be sure that the terms still apply.
The most obvious situation where a partner may need to be bought out is upon their death. Hopefully you’ve got that covered in your agreement so you don’t inherit owners that are descendants of your partner who may not add to the business like your partner did. The language for a buy-out upon death should be fair and reasonable for all owners. This agreement should establish a fair market value for the share of the decedent and have a plan for funding that will not cause undue harm to the business. Life insurance may be a very efficient way to see that your plan is fully funded.
Review the valuation each year. Not only is this what the IRS would like to see, it is also the most equitable way to know what the descendants of a partner would be entitled to receive in exchange for the partner’s interest. Your agreement is likely to be binding, so be sure that these values are reasonable to everyone while they are alive and healthy.
Disability is a little tougher than losing a partner to death. Just how disabled is your partner? Can they work? Should they be paid during the period of disability? At what point are they considered totally and permanently disabled and forever unable to work? And when do you trigger the automatic buyout due to that long term condition?
A lot of questions, but these issues are significant to both the company and likely the family of the disabled partner. This risk can be covered by insurance also, but the cost of disability buyout insurance may be too high for some businesses. If the buyout is to occur out of future revenues, be sure that between the loss of a working partner and any other consequential losses that these payments are sustainable.
In addition to health related issues, sometimes a partner simply wants to move on. Make sure that your agreement is clear with respect to the rights of each owner. You may have issues with respect to non-competition or non-disclosure, intellectual property, branding, employees and a number of unplanned consequences of a partner’s departure. While someone may indeed suffer as a result of the business divorce, the best time to agree on the terms of “what happens if” is when things are going great and the business is thriving.
John P. Napolitano CFP®, CPA is CEO of Napier Financial in Braintree, MA. Visit JohnPNapolitano on LinkedIn or napierfinancial.com. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.