Co-owning a small business with a
partner can be a recipe for success for many entrepreneurs. The
partners’ different skills and experience can come together to make
a stronger business than either of them would have separately.
With all the demands on their
attention, busy entrepreneurs can easily overlook important long-term
planning, such as creating a shareholders’ agreement. These
agreements can ensure that shareholders’ rights and obligations are
clearly understood and can protect the company’s future in case
something goes wrong.
Of course, it’s vital that these
agreements achieve their business objectives but it’s also
important to carefully consider their tax consequences. A
shareholders’ agreement sets ground rules for important issues such
as who can own shares of the business. For example, is ownership
restricted to the partners and their family members or will key
employees be able to own shares as well? And how will the shares be
valued if they’re transferred among the owners?
These agreements also deal with more
difficult issues, such as what will happen in case of a future
disagreement or death or disability of one of the key shareholders,
usually by specifying a process for one side to buy out the other and
how the buyout will be funded.
Though business partners may be
reluctant to bring up these issues, it’s best to create a
shareholders’ agreement when things are going well. In my
experience working with private company owners, people often regret
not having put things in writing when disagreements arise and they
realize they misunderstood each other’s intentions. If you’re a
co-owner and you are considering the options for your shareholders’
agreement, keep in mind that the tax implications of your choices can
be significant. For example, you’ll need to consider what will
happen to a shareholder’s shares on his or her death. Private
companies often take out life insurance policies on their key
shareholders so the business will have funds to redeem the shares.
Many flexible insurance products are available to create these
arrangements. When you’re considering the options, remember that
the arrangement’s structure will affect its tax consequences to the
company and the shareholder’s estate. In some cases, a tax benefit
can be available to one party but not the other. It’s important to
specify your intentions for this benefit in the shareholders’
agreement to help prevent future conflict.
One benefit of company-owned life
insurance is that the proceeds increase the company’s capital
dividend account, which can be paid to shareholders as tax-free
capital dividends. Along with capital dividends, another potential
tax benefit is the $800,000 lifetime capital gains exemption
available to individuals who dispose of qualifying small business
If your company’s shares qualify, you
may want to structure your shareholders’ agreement so the party
selling the shares can claim the
Once you have your agreement, you
should review it often, about every three to five years, or as family
or business circumstances change.
A shareholders’ agreement is a
critical part of any co-owned private company’s succession plan.
It’s like a prenuptial agreement or a will – no one likes to
think about needing one. But if something does go wrong and a key
shareholder wants to leave or dies, a good shareholders’ agreement
can help save the business’ value by providing for an orderly
transition and ensuring that the company or the surviving shareholder
has the funds needed to buy the departing shareholder’s shares.
Among all the decisions you and your
partner will have to make when creating your agreement, you’ll want
to make sure it’s structured tax-efficiently, both to save tax and
to help avoid costly litigation.