Let’s say you are the part-owner of a closely held corporation with one other partner. If your partner gets divorced, do you want to be in business with the proverbial “bitter ex-spouse”? If your partner dies, do you want to be in business with their widow/widower, or worse, their ungrateful, ne’er-do-well kids? Or, if your partner decides to retire or move on to another business, do you want them to be able to keep their ownership of the corporation and be a free rider on your future efforts?
Death, divorce and other life/career transitions are things that people tend to avoid talking about. However, they are a reality for many companies, and often unexpectedly so. Having the difficult conversation and putting in place a stockholder agreement in advance can help protect the company, the stockholders, and their families from being blindsided by these events. In a sense, stockholder agreements are for corporations what wills and trusts are for individuals – they put a process in place for when the unthinkable happens, and they don’t matter until they do, at which point they matter a lot.
Even when a company has a stockholder agreement in place, is important that companies revisit their stockholder agreements from time to time to make sure they still reflect the realities of the business. Often, stockholder agreements provide for buyout in certain scenarios, which may be at a fixed price (sometimes tied to the amount of a life insurance policy) or based on a formula, or may require an annual valuation. These prices or formulas may cease to be appropriate if the corporation’s business and finances change over time, and could lead to an artificially high buyout price that could cripple the corporation, or an artificially low buyout price that would fail to treat a departing stockholder (or their family) fairly.
While stockholder agreements can be complicated and force difficult conversations among business partners, owners of closely held corporations should strongly consider putting one in place (or updating out-of-date agreements) to ensure survival of the corporation and fair treatment of the stockholders and their families when the unthinkable occurs.