Any closely held business with more than one equity owner should have a written agreement governing each owner’s rights and obligations with respect to the business. For corporations, the shareholders may memorialize these agreements in a shareholders’ agreement, while the provisions typically appear in an operating agreement for limited liability companies. The ideal time to enter into the written agreement is at the inception of the business, but the owners may decide at any time to prepare an owners’ agreement. Time is of the essence, because certain events outside the control of the owners, such as death, divorce or disability, may adversely impact the business if the owners haven’t agreed in advance how they will address the issue.
What issues should the owners’ agreement address?
- Transfer of shares. Without restrictions on transfer, one of the owners may transfer his or her equity to another person or entity without the approval of the other owner, who then is in a business relationship with a new partner. Or an owner may transfer interests to children who are not capable of running the business, or who do not share the same approach to fiscal management.
- Death. If an owner dies, the surviving owner may not want the deceased owner’s equity to pass to a spouse or children, particularly if those persons had no previous involvement with the business. An owners’ agreement may provide for the purchase of the deceased owner’s equity by the surviving owner, and it may also give the surviving owner the ability to pay for the equity over time to avoid liquidity pressures.
- Disability. If an owner, who is active in the business becomes disabled and unable to work, an owners’ agreement may provide for the disabled owner’s equity to be purchased by the other owners.
- Divorce or Creditor Claims. An owners’ agreement should address the possibility that one of the owners may divorce, and the ex-spouse may claim ownership of the business. An owners’ agreement may provide for a buyout rather than bring an ex-spouse into ownership of the business. Similarly, a creditor of one of the owners may try to attach equity in satisfaction of debts, and an owners’ agreement may protect the remaining owners from the impact of these claims.
- Control over Decisions. An owners’ agreement may require the consent of minority owners for certain issues, or it may give the minority owners the right to name a director or manager of the business.
- Exit from the Business. If an owner leaves the business, the other owners may prefer to redeem the exiting owner’s equity rather than have him or her remain an equity owner. Further, the owners’ agreement may include restrictions on the former owner’s ability to compete with the business or solicit its employees.
- Sales of the Business. An owners’ agreement may give the majority owners the right to force the sale of the business, or it may require a process if an owner desires to sell to a third party.
- Dispute Resolution. An owners’ agreement may establish a dispute resolution process to minimize the risk of messy litigation.
For all of these issues, owners should reach agreement and finalize the owners’ agreement before the issue actually arises. Taking proactive steps to insulate the business from potentially adverse events will result in better planning for the future success and stability of the business.
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