Using Shareholder Agreements to Avoid Problems in Family-Owned Businesses
Learn how to craft solutions before problems arise.
By Martin J. Lieberman
Cover story for Big Ideas for Small Business, June 2007
Less than 30% of family-owned businesses survive to the next generation. Learn from expert Martin Lieberman how to craft solutions to potential problems before they arise.
According to the U.S. Small Business Administration, as many as 90% of all U.S. businesses are family-owned. But many of businesses here today may be gone tomorrow because of conflict within the second or subsequent generation on who should get what from the business and who should do what for the business. Martin J. Lieberman, CPA/ABV, ASA, a partner in the accounting firm of Weiser LLP in New York City, who has more than 30 years experience in valuation of closely-held businesses, provides some insights and advice to help family businesses overcome the challenges that often lead to their demise.
The problem
Parents may start a business and want to pass it on to their children. They may gift a portion of the business to children during their lifetime or leave the business to the children when they die. The children may have different talents and/or interests in the business. For example, one sibling may work long hours running a department while the other sibling barely shows up and contributes little to the company's success. Still, the underperformer may believe he/she is entitled to an equal share, regardless of his/her participation in the daily survival of the business. In effect, sibling rivalry may play out in financial terms that can be detrimental to the business and the family's wealth.
The solution
Before parents take any action to give children a share of the business, plan for contingencies. This means drafting a shareholder agreement that addresses foreseeable issues and provides mechanisms for resolving what can't be foreseen. Be sure to address:
Compensation. As in the case of professional service firms, which base compensation on how much time each professional spends and how much business each brings in, family-owned businesses can devise their own formulas for payouts.
What happens when an owner wants out. Parents may want all siblings to be involved in the business, but the children may see things differently. If one sibling no longer wishes to work in the business, decide in advance what happens--is his/her share bought out or will the sibling remain a "silent partner?" Make plans for a buy out; devise a formula for payment if the sibling remains as an investor only.
What happens when problems cannot be resolved. Obviously, even the best-written shareholder agreement may not envision every possible situation that may arise. The family may be able to work things out informally. But if this does not occur, the agreement should specify how problems are to be resolved:
- Family business consultants, who are experts in helping families to communicate
- Advisory boards, which can be formal (paid) advisors who counsel owners on how to run the business and deal with special problems. Usually it's best to not include on the board an attorney or accountant with existing ties to the family.
- Mediation, a process where an independent third party helps the family to reach a consensus
- Arbitration, a process where the family agrees to abide by the determination reached by a third party
Idea: Find family business consultants and advisors through recommendations by the company's accountant and attorney or through the Family Firm Institute.
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