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How to Mitigate Risks of a "Business Divorce" before it Happens...

Post from Daniel Young, Lommen Abdo Law Firm

lommen.jpgAs many veteran business owners are aware, it is critical to address early and up front various triggering events that may give rise to a "business divorce." Important items such as, knowing who your co-shareholders are, how liquidity events such as marriage divorce, disability or death will be met, keeping the business in the family and how the business will be continued or transitioned when the current active shareholders are no longer around, should be addressed and committed to in writing.

Failure to do so can easily result in a whole host of problems, including unwanted and/or hostile shareholders, an ex-spouse owning your co-shareholder's stock, termination of the S corporation election, forced liquidation of the business to meet shareholder buyout obligations or to satisfy state and federal income or estate tax obligations. Failure to properly address these issues can result in protracted litigation which is both expensive and distracting from managing and running any business.

Every corporation with more than one shareholder should have a buy-sell agreement that adequately addresses these issues and more. It is common for well drafted buy-sell agreements to clarify these potentially damaging situations by addressing a ban on unpermitted transfers of stock, and create rights of first refusal in the name of the corporation and other shareholders, just to name a few.

Funding methods such as life insurance policies, seller financing - or both - can be used to fund the share purchase. Valuation methods should be addressed in advance with shareholders (likely to be either the buyer or the seller and therefore likely to be reasonable and fair in their approach).

Your attorney must also be familiar with and address in the agreement the Internal Revenue Service requirements necessary to make the price and terms binding on the IRS. Failure to do so can have devastating effects. Likewise, the share purchase must be structured to maximize the likelihood of capital gain treatment in the event of a sale of the company.

Early on, active shareholders are often ebullient concerning the business's prospects and their ability to always work out and reach an agreement on their differences. Personal or economic stress can dampen that spirit. Common areas of contention include: unequal compensation, additional capital contributions, debt guarantees particularly where net worth and liquidity are unequal, vacation days taken, whether a position on the board of directors and as an officer is guaranteed, whether dividends are to be paid, whether all disputes are to be resolved by arbitration, whether employment with the business is for life regardless of cause, etc.

The list is legion. Be advised that the dynamics can often change in unexpected ways. What was once thought to be a harmonious relationship can change overnight.

The key thing to remember is that business divorces, like marriage divorces, can be every bit as expensive and acrimonious. It is best to document your agreements with your co-shareholders in the form of a shareholder control agreement. It is best to avoid one-size-fits-all solutions. Seek advice from trusted professionals such as your attorney, accountant and/or insurance agent to address your special and unique circumstances.

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