Many business relationships, like other relationships, begin with the rosy assumption that there will never be a problem that cannot be resolved by reasonable people, particularly if dear ole Dad (or Mom) is still around. Experience shows, however, that there are frequent cases of “deadlock” resulting in interminable friction or, even worse, litigation, after one or both parents are deceased.
Some wags have described small business as a “marriage without sex.” When both parents are dead or badly disabled problems inevitably will arise, and deadlock can result when the surviving children-owners reach a point that they can no longer “stand each other.” I have seen this pattern occur in my family and many other small businesses upon the demise of both parents.
Deadlocks can arise when, because of persistent disagreements, no one surviving child or group of children can effectively exercise control and make decisions. Often preceding deadlocks, there is a common pattern of arguments among your children. The trauma of the death of the key business founder(s)-parent(s) can be the tripwire to discord.
Far too often, attorneys and advisors assisting family businesses fail to advise the controlling parents of the common problems that arise when the company founder(s) passes on. For example, one or two children shareholders: (a) may refuse to guarantee new or existing business debt, (b) refuse to work full-time, or (c) refuse to participate in business meetings or activities.? The list of trouble spots can go on and on.
Perhaps the more common source of deadlock is simply the certainty that, over time, there will be disagreements. As in marriages, people and situations change and mature over time. Most businesses’ disagreements can be resolved; but some can’t and, when the differences cannot be reconciled, deadlock may ensue, particularly with two equal (50-50) children owners.
Surprisingly often, there are disagreements about who owns how much stock or business interest. (Tip: if an “S” election has been filed, IRS Form 2553, answers to stock ownership questions may be found there). Additionally, if there is a “minute book,” the answer to ownership may be in the minutes or stock certificates, which are usually found in the back of the minute book.
Most small businesses need some or all of the following planning devices, regardless of whether it’s a corporation, partnership, or LLC; although the precise terminology may change:
(1) Stock certificates (in LLCs, certificates of ownership) or other clear records of ownership to establish ownership and control.
(2) Bylaws (or a partnership agreement or LLC operating agreement), which are similar to a constitution or charter and are used to define and describe basic operating functions and procedures. These include such details as how many people are needed for a valid meeting and what percentage of agreement is needed to approve a matter. Without these basic governing devices, if there is disagreement, the parties usually cannot agree as to how or in what manner they will resolve it.
(3) Buy-Sell agreements (sometimes called stock redemption agreements), which can be used to address the consequences of events like death, disability, retirement, or the termination of employment of a family-owner or their children. Often, such agreements will also include “covenants not to compete” or nondisclosure provisions designed to prevent the departing business associate from taking customers or business knowledge and using it in an impermissible manner.
Whether you have all or some of the above mechanisms will depend on the owners and their willingness to think about “tomorrow,” before an important entity-splitting decision is thrust upon them.
Assuming all else fails and the children remain at loggerheads, there is the judicial system. Most states have some form of judicial remedy to remove the impasse. Litigation growing out of business deadlocks, like divorce proceedings, is usually bitter because the business disagreements can fester into personal animosities.
Think about tomorrow! Don’t allow your family-business relationship, or those of your children, to go unattended.