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Avoiding Second Generation Shareholder Litigation

Protecting the Second Generation from Oppressed Shareholder Claims

In my last post, I addressed how you and your business partner, as equal 50% shareholders, can protect yourselves from claims brought by the next generation once you begin to turn over the company reins.  This time I want to discuss other difficulties that can be encountered when turning the company over to your children, and how to protect your children from oppressed shareholder claims.

When only one of you has a child who will work in the business, but ownership will still be divided between both your offspring, problems – although not insurmountable once – may arise.  The biggest area of dispute is likely to be compensation.  The next-generation shareholder who has worked in the business for years, and who knows the finances inside-out, will likely wind up setting his own salary.  And every dollar that he gives himself as a bonus is one dollar less that can be paid out as a dividend and split evenly.

How is the shareholder on the outside supposed to know whether he is being treated fairly?  If you and your business partner have passed on the company to your children, should you care how they get along in the future?

I don’t have to tell you that you should care, because if you’re reading this article, you probably do care.  And why shouldn’t you?  You worked for years building up the company.  Why would you want to see it torn apart by shareholder dispute litigation between your children?

You can take steps now to prevent such fights, including making sure that mechanisms are in place for transparency, especially with respect to the finances.  One client set up a mechanism for an outside consultant to set all salaries for the company, providing in the shareholder agreement that all shareholders had to agree on the choice of consultant.  This particular client and his business partner had never had a disagreement in over thirty years in business, so some people thought that having salaries set by a consultant was unnecessary.  But he saw that his son and his business partner’s son did not see eye-to-eye on several things, and he knew that only one of them would work in the business.

This approach might be a waste of $5000 per year.  Or, it just might be the thing that prevents shareholder dispute litigation from tearing the next generation apart – and with it, the company that the partners spent the better part of their lives building.