Everyone is starting to realize that Millenials are going to be a generation of entrepreneurs. I'm also incredibly excited that the Madison, WI community is recognizing this. Yet, with everyone helping to make our dreams of entrepreneurship become a reality, we need to be sure that we are ready for what lays ahead.
We held an event last week as part of our ongoing Entrepreneurial Toolkit series that focused on Business Succession Planning. The turnout wasn't so great. I attribute this partly to the fact that most people don't take the topic seriously. However, with so many people wanting to jump into entrepreneurship earlier in life it becomes increasingly important to understand what you're getting into.
Let's look at a few examples that might not be so far-fetched:
Scenario 1: You and your best friend decide to start a company and create a LLC. If you're in Wisconsin, this means that you're adopting the default partnership status and you're splitting equity 50/50 (this goes for other states as well). The company does very well and you start to take on employees. In the meantime, one of you gets married. Unfortunately, you also get divorced. Guess who might own 25% of the company?
This particular situation can be taken care of using a certain type of buy-sell arrangement. This agreement allows the equity to remain with the original founders by giving them an opportunity to buy out the shares of the others in certain situations. There are other advantages to the agreement as well. For example, it has the benefit of increasing the purchaser's cost-basis in the company, which can mean lower taxes down the road.
What happens if you don't have the funds for the purchase resulting from a particular buy-sell arrangement? In the previous scenario, you may be able to take out a loan from the bank to cover your partner's share. In some cases, such as death or disability, key person insurance might be an affordable option for preventing this scenario. In others, maybe your company decides to set away money that can be used at a later date.
Here's another interesting situation:
Scenario 2: You and you're best friend decide to undertake another venture. For the first six months, you both work tirelessly to get the company off the ground. It's a struggle and at times your persistence wavers. Six months in, one of you decides that you aren't interested in continuing with the company. In leaving, you take 50% of the company with you.
While this particular topic isn't exactly addressed through succession planning per se, it can be addressed through other means. Many companies (and investors) address ownership issues such as this through vesting schedules. It is common that an individual's equity in a company will vest over a three or four year period, requiring them to stay with the company to receive their share. Leaving a year into a three-year vesting schedule would only leave you with a third of the shares you were originally appropriated. In addition, investing parties typically have additional terms, requiring key persons to stay on for a period of time.
There are a lot of reasons that buy-sell arrangements and vesting schedules might come into play. A company's key employees may need to leave for many different reasons (a significant other moving away, a death in the family, or financial troubles are just a few others). I hope that these scenarios highlight the fact that these situations might not be that improbable.
Lastly, to be clear, I'm no expert in this area, and none of this is legal advice. If you are interested in learning more, talk to a lawyer, financial planner, or your insurance company. If they can't help, they can probably point you in the right direction.
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