How Do We Avoid Surprise Partners in Our Family Business?

William “Bill” C. Davell, Esq.

The Good News provides a monthly column with important content having to do with topical subjects from the legal community. We hope our readers enjoy the perspective offered. This month’s legal opinion is provided by Douglas H. Reynolds, Esq., and Henny Lawrence Shomar, Esq., directors with Tripp Scott, PA.

Ask Bill: In starting a family business, you hear and read about unexpected changes in family structure that leave outsiders or even family members not originally in the company with unintended control. How do families avoid or manage such “surprise partnerships?”

 

Douglas H. Reynolds, Esq
Henny Lawrence Shomar, Esq.

Reynolds & Shomar: It’s right to be concerned. Family businesses are big business in America – they account for almost 60% of gross domestic product and 63% of workers. Sometimes really big: Walmart, Ford and Amazon are examples of global corporations still controlled by family members.

Moreover, Amazon is an example of a company whose ownership has been affected by a change in family structure – the divorce of its founding couple, Jeff Bezos and the recently remarried MacKenzie Scott. 

That transition was settled amicably, as Ms. Scott walked away with $35 billion(!) in company shares while Mr. Bezos maintained control. But other high-profile situations, such as Frank and Jamie McCourt’s major-league divorce battle over ownership of the Los Angeles Dodgers, and Donald Sterling’s disputed capacity to administer a family trust owning the Los Angeles Clippers, show that isn’t always the case. 

According to the STEP Project for Family Enterprising and consulting firm KPMG, successfully “governing” a family business requires “transparency, purpose, intent, and flexible mechanisms to reduce ambiguity and conflict.” 

Those factors begin with considering at the very outset, in structuring partnership, shareholder and operating agreements, the potential effects on the business of divorce, dementia, or death – and a surviving spouse’s, ex-spouse’s or heirs’ possible involvement.

 

Ask Bill: What kind of changes have to be taken into account?

 

Reynolds & Shomar: In addition to Bezos-type couples who become partners in a successful enterprise and later divorce, it can include an owner who gets married. In either case, ex- or new spouses can gain a business interest. Or a business partner can die or become mentally incapacitated, with his spouse, heirs, or guardian assume his ownership and control in the business.

 

Ask Bill: But we’re Christians. I have no intention of getting a divorce.

 

Reynolds & Shomar: No one gets married expecting to divorce. But according to Pew, 28% of divorced Americans claim to be evangelicals, so it’s still something that must be planned for in forming a business.

And since differences over managing a family company could conceivably strain a marriage (“money fights,” including a lack of communication about finances, are the second-leading cause of divorce, per Dave Ramsey’s organization) creating mechanisms that ensure transparency and shared purpose and intent might actually relax tensions.

 

Ask Bill: So how should we prepare for unexpected family changes?

 

Reynolds & Shomar: Either as the business is formed, or even after it is operational, the following instruments can help ensure smoother ownership transitions should unforeseen events occur.

 

Pre- and post-nuptial agreements can avoid disputes or unintended involvement by establishing how much — if any — of a business interest or operating role a spouse will receive in the event of a divorce. Pre/post-nups can protect a couple that owns a business together, or one spouse who owns a business in which the other had no involvement yet later claims an interest or an operating role upon divorce. It could also protect a third party with ownership equal to a party getting married or divorced from finding him/herself with a new partner.

 

Organizing documents. Articles of incorporation, bylaws, operating agreements (founder’s agreements), and even employment contracts involving the owners can be structured or amended to delineate or instruct who can own or buy shares and whether the owners may purchase ownership interests from either the ex-spouse, owner in question, or any other impermissible transferee. 

 

Buy-sell agreements can ensure against the transfer of shares without the approval of the other owners and also can require that a divorcing spouse automatically convert his or her stock upon transfer to stock with a non-voting interest. 

 

Non-compete agreements inserted into the operating agreement could prevent widows/widowers or ex-spouses receiving stock transferred by death or a divorce proceeding from competing with the business.

 

Decision-making authority in death and mental incapacity. If a partner dies or his or her mental capacity is challenged, governing documents can proactively codify decision-making authority to prevent it from reverting to a spouse, beneficiary, guardian, or a court-appointed party – thereby reducing reduce risk and shareholder expense.

 

Family businesses may be big business, but it’s bad business to leave their future direction and control to chance – especially if you may be interested in attracting future partners or investors who won’t be attracted to uncertainty. So discuss these matters with an attorney experienced in corporate structure to ensure that future family disputes remain about what’s for dinner – not who’s in charge.

Read more Ask Bill at: https://www.goodnewsfl.org/author/william-c-davell/

 

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