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Posted: January 22, 2013

The life and death of a small business

Plan for the end at the beginning

Cindy Wolf

When you start your business, you’re full of hope and dreams. You may be a sole owner, have a partner or plan to create a family business. And when it goes well, you’ll run the business for decades. But what happens when you want out?

There could be many reasons: you’re ready to retire; your family isn’t interested in continuing the business; your partner is no longer compatible or is unable to continue with the business for some reason. Or what if your partner dies? Or you die?

Nobody likes to think about what happens when it’s all over. But failure to plan for that event is a real disservice – to yourself, your business and your family. Let’s look at what could happen to Bob and Sharon’s business if Bob died suddenly. If they didn’t plan ahead and have a Shareholder Agreement or Operating Agreement with terms about what happens when an owner dies, Bob’s interest will pass to his heirs.

They could include a spouse, child, other relative, a trust or foundation or some combination of them. Let’s hope he at least has a will. But in any event, none of the heirs may have any interest in working in the business, or may not be qualified to do so if, for example, Bob was a dentist or other licensed professional. But the heirs still have a right to Bob’s share of the profits and a say in the management. Whatever Bob contributed to the business in terms of productivity, sales, service or cash is gone and the new owners may have unrealistic expectations about the inheritance they just received.

Sharon is faced with a quandary. Can she buy out the new owners? Will the new owners sell? How much is it worth? Does she want to buy out the new owners? Can she continue operating the business alone? Even to fulfill existing orders? And don’t forget that Sharon has probably also lost her best friend (or possibly her spouse) so she’s not her usual happy, clear-headed self.

Divorce is a risk for small companies, particularly when both husband and wife are owners. The business is one more asset to divide (and fight about) in a divorce and may be the primary source of income of one or both spouses. Without an agreement about how an owner can exit the business, a divorce could destroy it.

Divorce can also challenge the ownership structure of the business if there is no agreement defining how new owners are brought in. Let’s say that in our fictitious business, Bob doesn’t die, but instead divorces his wife Karen. As part of the divorce settlement, Karen gets 50% of Bob’s shares in the business. If Bob and Sharon were equal owners previously, now Sharon is the majority owner. She has total control for any decisions requiring a majority vote. But now Karen can totally change the dynamic for decisions that require a unanimous vote.

Unmarried co-owners may also hit a point where they need to break up – which can feel like a divorce depending upon the reasons (money, betrayal, lack of attention, etc.). When there are no agreements in place, an owner that wants to leave the business (or force another owner out of the business) may end up losing his or her investment or having to sue to dissolve the business to get out. It’s not like selling off some shares on the stock market.

The lesson is to plan for the end at the beginning – or at least in the early stages when co-owners are still alive, healthy, friendly and cooperative. There should be no embarrassment about agreeing on a buyout clause or getting life insurance or other investments to cover the loss of a key member or fund a buyout. And if tragedy strikes – or life happens - a process is in place to manage the situation.

 Cindy Wolf is a Colorado lawyer with more than 25 years experience representing large and small domestic and multinational companies. Her expertise is in corporate law and commercial contracting, with an emphasis on international issues, technology licensing and the Internet. She can be reached at cindy@cindywolf.com  or visit her blog at www.cindywolf.com

This publication is provided for informational purposes only. It does not constitute legal advice. There is no implicit guarantee that this information is correct, complete, or up to date. This publication is not intended to and does not create an attorney-client relationship between you and the author.

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