Business Succession Planning: Initial Considerations Before Succession Begins
FIVE KEY ISSUES FOR EVERY START-UP BUSINESS
We routinely assist clients in setting up businesses for any number of reasons and purposes. In each and every case, we demand that our clients address five key issues, preferably before they take their first step in their new venture. When a client comes to us with an established business, we similarly insist that the client immediately focus on the same five issues. In both cases, we counsel clients that addressing these issues in advance will simplify the succession process in the future. While the issues are identical in each case, the answers are specific to each client and generally require detailed conversations not only with the client but with the client’s other professional advisors and, when relevant, the client’s co-investors, co-owners or successor owners. These issues are as follows:
- Choice of Entity. In each case the client must first decide whether the new entity will be a limited liability company, a general or limited partnership or an S or a C corporation. Similarly, we review with clients who have existing business their current choice of entity and whether a conversion is appropriate. In both cases, this discussion is often but not exclusively tax-driven, and also includes the longer-range plans for the venture.
- Choice of Jurisdiction. Similarly, the jurisdiction in which the entity is organized warrants extensive discussion. This is also an issue that is tax-driven, but has other considerations, such as the content of the jurisdiction’s body of relevant law governing the rights, duties and obligations of and between entities and their investors. Again, with an established business, we discuss with the owners whether the entity should be reorganized in a more appropriate and beneficial jurisdiction.
- Governance. Issues regarding the governance of the entity should be addressed in the entity’s organizational documents up front to reduce the chance of disputes at a later date. The entity’s organizational documents should resolve mundane issues such as the identity, number and election of officers and directors. They should also identify which issues will be resolved by a simple majority and which extraordinary issues will require a supermajority if not unanimity of the principals. Though frequently overlooked, these documents should be reviewed periodically by the principals of established business entities to ensure that they still comport with the wishes and expectations of the principals.
- Transferability. The organizational documents should also define whether an investor or owner can transfer his or her interests in the entity. As a general rule, investors in a closely held entity want to control who can become an owner and not allow interests to be freely transferable. Again a periodic review of these provisions should be made to ensure that they consistent with the expectations of the principals.
- Trigger Events. Finally, the organizational documents should define the events that would require an investor, or an investor’s representative, and either the entity or the other investors, to buy an investor’s interest. For example, what happens to your ownership interest on your death or retirement? As part of these provisions, the purchase price should also be fixed, along with the mechanics for satisfying the purchase price. Too frequently the provisions establishing a purchase price are ignored until it is too late, and parties find themselves in the untenable position of defending or challenging a fixed purchase price that is inconsistent with the current value of the venture.
While cliché, the axiom that “an ounce of prevention is worth a pound of cure” is never more true in discussions associated with the launch of a new business venture. With an appropriate foundation that resolves these issues, the new entity and its investors reduce the likelihood of distractions, both costly and incidental, that detract from the mission.