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Creating a Succession Plan While Avoiding Litigation with New Business Partners

Surviving in business is difficult with a business partner, especially when you are both 50% shareholders, with neither of you in total control.  Cooperation and trust are critical, and the relationship could have fallen apart at so many different times over the years.  Disagreements about the future direction of the company likely have occurred, but you survived them all.  As you approach the age where you can begin to see your retirement on the horizon, questions inevitably arise about the future of the company once you are no longer there.  When you are a co-owner, you also have to consider whether your business partner has the same vision of the future that you do.

You would be surprised to know just how many savvy business partners have never addressed – or even discussed – a succession plan.  Do you both want to sell at some point?  If so, when?  Do you both want the next generation to run the business?  What if one of you wants to sell, but the other wants the children to take over?  If your children run the business, will you give away all your shares first, or will and your partner continue to maintain ownership control?

It is critical that these issues be decided as early as possible, certainly before it’s time to implement a succession plan, whatever that plan may be.  Although these are corporate planning issues, the statute (at least in New Jersey) governing shareholder oppression and minority shareholder rights has a large impact on how these issues should be addressed.

If the plan is to leave the business to the next generation, it is quite common to gift shares over a period of years as an estate planning tool.  To protect the founding generation, shares are often gifted as non-voting shares, so that control is maintained.  But, in New Jersey, those new minority shareholders now have certain rights – even if they are your children.  They may sue for shareholder oppression, which is defined in a variety of ways, and, under the statute, includes the broad category of “unfairness” towards the minority.

One recent client gifted his shares to his son, while his business partner did the same with his daughter.  Instead of being grateful for the windfall, both children (in their 30’s) felt entitled, and complained about the large salaries being taken by the majority shareholders who had not only gifted them their shares in the first place, but still ran the company, as they had for three decades.  Those complaints turned into a lawsuit, and the majority shareholders soon wished that there had been some way to address this issue up front, rather than through expensive shareholder litigation.

Even if you are correct in your belief that your child would never sue you, are you as confident that your business partner’s child would never sue him?  Or you?

Although it is unavoidable that a minority shareholder would have certain statutory rights in New Jersey that cannot be waived, there are ways to craft a new shareholders’ agreement that can limit the exposure to such a suit.  For example, the new shareholder, when he receives his shares, could acknowledge in a new shareholder agreement that he is aware of everyone’s salaries, recognizes such salaries to be fair and justified, and concedes that he is to have no role in the future in setting salaries.  This one precaution would protect, to a certain degree, one generation against the claims brought by the next.  But, what of the second generation itself?

How to prevent claims between or among the members of the next generation – claims that could tear apart your business, and your legacy – will be dealt with in my next posting.