The Business Continuity Agreement
Incredible Result: “Our Owners will always get along. Period.”
Avoidable Train Wreck: Avoidable co-owner disputes crush you.
Main Play: The Business Continuity Agreement
What This Is: Your Owners have agreed in advance to protect the critical unity between existing and future Owners with a dividend protocol, retirement guidelines, dispute resolution process, conflict of interest policy, Board of Director decision policy, tax decision process, and key person insurance.
Businesses, regardless of age and size, are often damaged or torn apart due to lack of a well-conceived system for avoiding and resolving disputes. These disputes can arise between co-owners, the spouses of co- owners and co-owner families.
The potential for disputes can become even more acute upon the death or disability of a key owner. The role of a spouse or other family member may take on a new significance when the other co-owners attempt to work out issues with the spouse or family member who may not be familiar with some of the innerworkings and understandings of long-term business partners. This issue can be just as problematic for a one-owner business which now finds itself being owned by a surviving spouse or surviving children.
In addition to issues regarding regular company operations, disputes can arise as to how family salaries are to be set, how dividend distributions are to be determined and paid and who is to run the business as your successor. The risk involves not only adverse financial impact to the Company, but also can pose a threat to keeping peace within a family. Various matters which functioned well when you were around as the “traffic cop” to avoid or resolve disputes might no longer function nearly as well. This can occur despite the best intentions and simply be caused by a difference of opinions.
The Business Continuity Agreement
In order to help minimize, avoid and resolve possible disputes amongst co-owners, spouses and family members, the Business Continuity Agreement is being deployed by Family Business Pioneers. This type of agreement operates in addition to a well-conceived Buy-Sell Agreement (discussed previously). The Business Continuity Agreement addresses issues other than buy-sell obligations. The following are some of the features which we recommend be included.
- Board Approval Actions. The agreement should spell out those actions which require Board of Director approval. The typical Articles of Incorporation and Bylaws for corporations do not specify this type of detail. Bylaws will typically provide that the Board of Directors is to elect the officers and will specify general duties of the officers. In some instances, the applicable state business corporation or limited liability company act will contain further types of actions which require Board approval. Beyond that, the boundaries of the officers and directors authority may be largely blurred and subject to dispute. This portion of the agreement can set forth the approval requirements for a sale of company assets, capital expenditures, loan transactions, change in accounting principles, acquisition of other businesses, issuance of additional shares, redemption of existing shares and the payment of bonus compensation.
- Right to Engage In Competing Businesses. Depending on the circumstances, the parties may agree that co-owners should not be restricted from investing in other types of business which may compete with the Company. On the other hand, you may have reasons for restricting the ability of your co-owners to invest in competing businesses. This is best resolved by a clear understanding of this between co-owners ahead of time.
- Confidentiality Provisions. As a business owner, you typically receive and are entitled to receive detailed confidential information regarding your business operations. Typically, the disclosure of that type of information to outsiders or competitors would be detrimental to your business. The agreement should specify a requirement to maintain proprietary information in confidence.
- Required Resignation. The agreement can specify that if a co-owner sells his or her shares in the Company, this results in an automatic resignation of status as an officer and director of the Company, unless the parties later agree otherwise.
- Financial Statement Requirements. The agreement can specify the nature of the financial statements which the co-owners expect. This may include audited, reviewed or compiled financial statements by an outside CPA on an annual basis along with the details for monthly and quarterly interim statements.
- Subchapter “S” Protection. Whether or not your Company is a subchapter “S” corporation today, the agreement can include provisions that require the protection of that status as it exists today and as it may exist upon election in the future. When the owners intend to have “S” status maintained, this agreement can help avoid a costly inadvertent termination of the election.
- Tax Payment Dividends. If the Company is a flow-through business, such as an “S” corporation or a limited liability company, then its income is taxed to the owners rather than to the Company. Since the owners are taxed on this, there should be an agreement in place under which the Company and the co- owners have agreed that sufficient dividends will be paid quarterly to the owners to enable them to make the tax payments on the Company income.
- Share Redemption Provisions. The owners may wish to have the opportunity to have some or all of their shares redeemed periodically. While this might result in full ordinary income taxation for “C” corporation owners, this type of periodic redemption can be tax efficient for an “S” corporation or limited liability company. Under programs that we have established, the Company’s board of directors can determine a redemption pool each year and allow owners to opt in periodically for a pro rata redemption from the funds available in the pool.
- Annual Dividend Payments. This provision can establish a policy which the Company will follow for determining annual dividend payouts. This is intended to help reflect a balance between those owners who are full time employees of the Company (receiving compensation) and those owners who are not employed by the Company (and who would expect to see some return through dividend payments).
- Non-Solicitation of Customers. These provisions can detail the limitations which the co-owners expect to have in place to prevent other owners from soliciting the Company’s customers for other businesses owned by a co-owner.
- Non-Solicitation of Employees. These provisions can specify that co-owners are prohibited from soliciting employees of the Company to work in another business operation of the co-owner without meeting agreed approval procedures.
- Board of Director Composition. These provisions can specify that each principal co-owner (and his or her family) is permitted to elect a certain number of the members of the Board of Directors.
- Retirement Guidelines. These provisions can specify when and under what conditions it is expected that a co-owner would agree to retirement.
- Profit Strategy Team. A Profit Strategy Team (also often called an Advisory Board) is being utilized more and more by companies of all sizes as a means to help provide company management with additional perspectives and experience which they might otherwise not encounter. This board can include lower level management members as well as outside business persons or advisors. The terms for this can be specified in the Business Continuity Agreement. This also provides an ongoing means of expertise and guidance upon the loss of a key-owner.
- Profit Plan Program. The agreement can specify the company will adopt a Profit Plan Program built on a continuous improvement and innovation process for your Business Model.
- Company Formalities. The agreement can also specify that the company will maintain standard corporate or LLC formalities and recordkeeping requirements. This would include holding regular owner and Board of Director meetings and documenting them with regular corporate or LLC minutes.
- Conflict of Interest Policy. In order to enable and require directors and officers to avoid conflicts of interest, the agreement can also contain the details of a conflict of interest policy.
The Business Continuity Agreement is not intended to diminish the control of the controlling owners. Therefore, it would typically be amendable or could be terminated upon the determination of a controlling interest of the Company, rather than all parties to the agreement. In addition, the agreement can provide that its provisions can be waived upon the determination of a controlling interest of the Company.
The objective of the agreement is to establish company guidelines, especially as they relate to business continuity issues. This agreement, in effect, lets all of the players know what the rules are, but it retains the ability of the controlling owner to change those rules as determined from time to time.
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