Pre-nups for small business

Plan your exit before you open the door

Last year, there were over 600,000 new business start-ups nationwide and even more are expected in 2000, estimates the U.S. Small Business Administration.

Behind each statistic and storefront lie the joys of starting a new enterprise with trusted colleagues and the anticipation of a collectively prosperous future. Yet as counterintuitive as it may seem, one of the first things that each of these small business owners needs to plan is their exit.

They must ask themselves what will happen when a key shareholder-a partner on whose expertise, labor, investment and friendship the business depends-becomes incapacitated, dies, loses interest, fails to perform or simply wants out.

Among the many questions a small business owner must consider are: Can a shareholder give his shares away to his family-or sell them to whomever he chooses? If a shareholder dies, will his widow or his children become owners of the corporation? Will estate taxes cripple the heirs, or possibly force them into bankruptcy? Will the shares go into probate? If a shareholder departs, can he sell his shares to a competitor? Can he start his own competing business? What happens if an owner simply kicks back and “retires on the job,” letting others shoulder the burden?

The reality is that relationships in closely held businesses-like other social relationships-break up every day, in whole or in part. When they do, the emotional and financial stakes can be every bit as high as those involved in a divorce.

Yet, year after year, thousands of business owners inadvertently leave decisions about the disposition of shares to sometimes arbitrary action by the courts, the IRS or squabbling heirs. As a result, the remaining owners don’t enjoy an orderly continuity or transfer of those shares, and their businesses inevitably suffer. By failing to anticipate such developments, they leave themselves, their partners and their heirs open to heartache, financial agony, excessive taxation and possibly even bankruptcy.

Nearly all those problems can be averted with the help of competent counsel and a simple, uncomplicated document known as a shareholder agreement, commonly known as a buy-sell agreement. Such an agreement spells out what happens to the business upon the departure of one of the owners.

A shareholder agreement should be written for every entity and should clearly define basic issues that each owner of a business should consider:

  • Who is entitled to own equity in the entity, in what amount and at what price.
  • How directors will be elected initially and under future arrangements.
  • How vacancies on the board will be filled.
  • How and when to distribute cash from the corporation to the stockholders.
  • Which activities require majority shareholder approval, e.g., spending, stock issuance, bylaw amendments, benefit changes, disposal of property or equipment, payments to shareholders, hiring or firing decisions, or purchasing property.
  • How, when and to whom stock may be sold or transferred.
  • What amount of insurance should be carried on the life of each shareholder.
  • What exactly happens to the shares held by a shareholder who dies, becomes disabled for a certain period, is terminated or files for bankruptcy.
  • How and when to determine the
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