More Than One Owner – Risk Losing Control?
Often, when I advise an owner who owns all of a business, I recommend that appropriate individuals be allowed to buy into the business. The reason for this is the overwhelming benefit of having an owner agreement with buy-sell provisions among the owners to assure appropriate control in succession and to protect the owner’s business interest value. It is a very good situation to have multiple owners where there is a competent owner agreement containing succession and buy-sell provisions. It is a very bad situation to have multiple owners where there is no owner agreement or a deficient owner agreement.
The Legal Basis for Control with Multiple Owners
The presence of other owners can greatly affect the actions of a majority-interest owner of a business. Usually, an owner of a majority interest in a business will be able to control the business; however, there can be significant problems relating to having other owners holding minority interests. When bringing in other owners with minority interests, the majority-interest owner intends to maintain control (including the ability to sell the business, control compensation, and make all important decisions).
The basic element of control is the legal basis of authority. A business should be operated through a legal entity that provides limited liability to its owners. The legal documents that set up the entity and the statutes of the state in which the entity is formed will provide certain procedures and define certain authority for owners and managers of the business.
In the absence of a relevant written agreement between the owners, the laws of most states provide certain rights to a minority owner. Upon the sale or dissolution of the business, the minority owner is entitled to a proportionate share of the proceeds remaining after all debts are paid. If there is a distribution of profits, the minority owner is entitled to a share of the distribution. The minority owner may demand an accounting of the business, usually a limited right to examine the books and financial records. If the majority owner oppresses the minority owner, typically by failing to observe one or more of the aforementioned rights or engaging in fraud, the minority owner may have the right to sue for breach of fiduciary duty. The remedies for such legal action could include receivership (where the business of the company is taken over by a court-appointed receiver) and the dissolution of the business.
Imagine an angry minority owner, vindictive over some real or alleged slight, initiating a legal action asking that the business immediately be controlled by a receiver and then over time be liquidated. While the majority-interest owner may ultimately prevail, all owners will have lost because of the damage to the business caused by the proceeding.
Moreover, no matter what the business entity, certain business decisions will require a super-majority interest agreement. Some important corporate decisions will require a two-thirds or three-fourths majority, and many limited liability company decisions require unanimous member (owner) consent. A dissenting minority interest could affect the majority-interest control on these issues. In the absence of a written restriction to the contrary, a minority owner could sell a minority interest to a third party (perhaps a competitor). Where there is a minority owner, the action of the majority owner will be limited by considerations of fiduciary duty and concerns with voting requiring a super-majority for action. Certain actions of the minority-interest owner (such as selling the interest to an undesirable party) should be restricted.
An Owner Agreement Assures Control and Stability in Succession
Where there are several owners, the majority-interest owner will be assured of control only if that owner pursuant to an owner agreement has the right to obtain minority interests from the minority-interest owners upon the occurrence of certain foreseeable events. These events are those situations where a minority-interest owner is likely to be dissident. For example, a written agreement between the owners could provide that in the event of a termination of employment, the minority ownership interest of an employee must be sold back to the business. Such an agreement between the owners also can deal with foreseeable issues regarding the death or disability of any owner, management involvement of the owners in short-term operating decisions and in critical business decisions (such as funding of the business or sale or merger of the business), payments to owners based on equity, and compensation payments to employees.
The are many horror stories are out there, familiar to us all. Multiple owners have failed to carry on the business, where a key component of the business, the primary owner-manager, dies or otherwise withdraws from the business. We have seen the chaos of failed succession in a family business where the sibling rivalry of owners destroys the ability of the business to function. Poor planning can result in the inability of a business to continue under the burden of estate tax payments due on the valuation of the business interest held by the owner at the owner’s death (no matter that immediately after the owner’s death the business may be worth much less than before the owner died).
For the benefit of both the majority and minority interest holders, issues of value and control in certain foreseeable situations should be the subject of a written owner agreement. The agreement should establish the triggers (death or disability are the two most common) that will cause ownership to change and the procedure for accomplishing that transfer, including a definite way to determine the value and how that value will be paid. The agreement, based on the succession plan of the business, should also provide for successor ownership.
The Owner Agreement Insures Value
As a business owner, how do you get the value of the hard work and sacrifice you put into your business out of your business? Can you make sure that you or your heirs receive the benefit of what you put into your business? You can see to it that when you cease to be an owner of your business interest that someone else will pay you or your family the highest possible amount for that business interest. That someone else will be the other owners of the business. This is a primary benefit of having other owners in the business.
The primary way to control a private business is providing leadership through policymaking. Leadership is provided when owners articulate their values, engage in group decision-making, and document their decisions with a written strategic plan, which provides a shared vision of what the business should accomplish. The managers define goals from the strategic plan and establish mileposts to monitor the progress of the action plan. Where there is a failure to meet a milepost, the action plan and possibly the goal must be reconsidered and the plan revised. It is this procedure of monitoring and revising that establishes and maintains the control of the policy-making owner. The strategic plan is the basis for the owner agreement protecting the value of each owner’s interest and providing control features in situations where statutory provisions or issues of fiduciary duty will cause foreseeable problems.
Policy-making owners who exercise effective leadership by implementing quality decision-making procedures resulting in the implementation of quality planning and an owner agreement with buy-sell provisions and minority ownership provisions will control their private businesses. Good decisions representing quality strategic thinking will yield better financial results. Better financial results will affirm control and increase the value of the business. The process is circular and reinforcing.
An agreement between business owners, dealing with the succession of a business interest and insuring each business interest, is difficult to create and difficult to enforce. Yet it is the essential element of wealth-building for the reason that it works. Because the agreement is difficult to create and maintain, many do not attempt it. Many owners try to skate through the issues creating a deficient agreement that can cause more problems than it solves.
If you can run a profitable business, you can create an owner agreement to guarantee your control of the business and that you or your heirs receive the maximum possible value from your business.