Business Succession and Exit Strategy
It is probably against your nature to think about how you will get out of a business venture before it has even had a chance to get going. However, this is almost always the best time to put mechanisms in place that will protect your interests in the event of a worst case scenario.
In our experience, these worst case scenarios generally rear their ugly heads in one of two ways:
- the relationship between you and your business partner/s sours to an unbearable degree usually caused by financial strains on the business or significant disagreement on the direction of the business; or
- the event of your passing away.
Soured business relationships
People’s priorities are ever-changing. As a result, you may find yourself running a business with a person or people who you no longer share the same chemistry with as you did at the outset of that business.
At the risk of sounding like the pessimist of your group of entrepreneurs, you should suggest that well-formulated options for exiting the business are integrated into any written agreement at the outset.
That written agreement will depend on the business structure you have chosen. We will discuss two common business structures and exit strategies to adopt for each one.
Entering into a partnership is an attractive option for small businesses as it provides a casual approach to running that business. However, one of the main things to consider is that each partner is bound by the other partners’ actions.
We have encountered cases where individuals thought they had left a partnership only to find out that they are technically liable for actions taken by their fellow partners long after they “left”.
Therefore, it is recommended that a formal partnership agreement is entered into which provides a clear mechanism for a partner dissolving the partnership so to not incur further liability at a later stage.
Partnerships of individuals also present exposure to liability issues against personal assets. Therefore, if a partnership structure is the preferred option, then consider a partnership of trusts with corporate trustees.
People may choose a company as the structure that carries on their business. Often, those people will be both the directors and shareholders of that company.
As a result, in the event of you choosing to leave a business that is run in this fashion, your issues may be twofold. First, you will need to consider the ramifications of resigning as a director.
Just like individuals who “leave” a partnership but continue to incur liability, a director who has provided personal guarantees for their business will not automatically be released from those guarantees as a result of resignation of a directorship.
The other issue is how to dispose of your shares in that company and therefore your interest in the business. This is something that should be considered in drafting the shareholders agreement and not left to chance.
Specific items that should be addressed in a shareholders agreement may include;
- How do we value the shares?
- Do my fellow shareholders have the first opportunity to buy those shares?
- How and when does payment occur?
The event of your passing away
Your interest in a business may be a considerable asset of your estate upon your passing. There a number of options available to you, regarding how those business interest are dealt with.
It is not uncommon for a shareholders agreement to include a mechanism for dealing with a member’s shares upon their passing. These may take the form of a buy/ sell clause or put and call options.
A buy/sell clause occurs when one party agrees to purchase the interest of another party upon the latter party’s death or incapacity. Issues regarding the valuation of that interest, etc. are generally governed by the terms of that buy/sell clause.
A put and call option is similar to that of a buy/sell clause except for the fact that it may not be mandatory for the other party to purchase the business interest.
Both buy/sell clauses and put and call options can be made in separate agreements with external parties so long as they don’t conflict with the terms of an earlier agreement such as a shareholder agreement.
Another option may be to account for your business interests in your will. This may take the form of you gifting your shares to a specific beneficiary.
Once again, the most important requirement is to ensure that the terms of your will do not conflict with any obligations you may have under any other agreement. Otherwise, you may cause headaches for your executor/s down the track.
We’re here to help
Should you require assistance preparing partnership agreements, shareholder agreements, buy/sell agreements, or your will, please contact Lynn & Brown Lawyers. We can provide you with an agreed fixed price for engaging any of our services.
About the authors:
Evan is a Perth lawyer at Lynn and Brown Lawyers, specialising in Litigation and general Commercial Law. Steven is a Perth lawyer and director, and has over 20 years’ experience in legal practice and practices in commercial law, dispute resolution and estate planning.