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Three Keys to a Smooth Ownership Transition

Timothy R. Hughes, Esq.
Hughes & Associates, P.L.L.C.

Sound and honest planning pays off when its time to give up a piece of the pie.

All businesses eventually face ownership transition issues.  Construction and design firms are no different.  Perhaps a business owner wishes to hand off the business to a relative.  Maybe ownership wants to give valued employees a “piece of the pie”.  Even business asset sales or  splits between partners present ownership transition issues.

Sound and honest planning on the front end can ease these transition moments.  Keep in mind that change of any type can be traumatic to a business, so prepare in advance for those adjustments.

1.  Define Your Philosophy

All individuals who are starting a company, even solo firms, need to establish an ownership from the start.  Having a solid philosophy of what it takes to enter the  ownership ranks permits frank discussions and communications with employees.  Clearly stated goals and parameters avoid miscommunication and reduce friction. 

I own a small business.  My philosophy involves engaging employees into a stewardship mentality towards the firm through enabling them to partake in the success of our company.  This type of philosophy cannot be merely word.  Instead, it must inform company decisions on a steady basis.  I keep this in mind when making decisions about available insurance coverage, year-end bonuses and profit sharing contributions from the company into our employee’s 401K.  The transition to ownership would require not just excellence in legal work, but also demonstrated commitment to the firm and a track record of successful business generation.

The same type of business philosophy needs to be established as to ownership transition.  Clear expectations should be set and communicated to employees about what it takes to be invited into ownership ranks.  If you ingrain your philosophy into your business, decisions become easier and clearer.

2.  The Way In  

Naturally, it takes more than a philosophy and an invitation to bring a new member, or a separate company, into a position of ownership in your firm.  If your company is a partnership, it is highly advisable that the financial and business understanding amongst the partners be reduced to a partnership agreement.  This is not an invitation to fight, but rather a tool for ensuring everyone is on the same page about rights, liabilities and expectations.

For limited liability companies of more than one member, an operating agreement is critical.  Similarly, for corporations, stockholder agreements, buy/sell agreements, and clear by-laws defining rights and obligations are critical.

The appropriate mechanism for bringing in a new owner can become very complicated.  For example, bringing a new individual into even a modest stake of a successful company can have unintended expenses.  A company valued at $1 million which simply gives a 5% interest to a long time employee creates tax liability to that employee for $50,000 of extra taxable income.  You may need to balance out taxes, income, and bonuses on the one hand against the employee’s desire for a piece of the pie and willingness to invest money to obtain it.

3.  The Way Out 

Clear ownership documentation also reduces the chance for friction in the case of an owner leaving or selling an interest in the company.  The most likely issues to be of critical importance are: purchase price; terms of payment; and conditions for the owner being able to sell.

The question of business philosophy extends into this arena as well.  For example, a company’s philosophy may make sales of stock to third parties extremely restrictive.  The sales price for the shares may set the company at an artificially low level.  These types of restrictions may help a company avoid paying large sums to employees who quickly depart.  When an owner dies, such restrictions may also have the unintended effect of depriving that owner’s family of estate assets.   A careful balance should be struck between short and long term interests of the business and the individual owners