October 23, 2003

Business Succession Planning: Maintaining Family Harmony

Holland & Knight Newsletter
Shari A. Levitan

With whom will you be doing business when your partner moves on?

Family members who own and operate a business generally have their hands full dealing with issues of finance, marketing, sales, distribution, accounting and management, and have little time to consider what effect the death or disability of a key family member would have on the continued success or even the survival of the business. Moreover, sibling rivalries and resentment can add a heavy psychological element to succession planning. For these reasons, planning often never gets done, leading to disastrous results.

Shareholder agreements allow business owners to grapple with difficult issues of future ownership and management – providing a process to be followed in the event of the death or disability of a participant shareholder, as well as addressing a variety of related estate planning and family issues, shareholder agreements can avoid or minimize family feuds and business disruptions. Shareholder agreements also address the concerns of inactive family members or trusts for their benefit. 

Subjects dealt with in shareholder agreements include:

Death of a shareholder

The death of a shareholder often results in the business being co-owned by the shareholders who are active in the business and the beneficiaries of the deceased shareholder’s estate, who may or may not be active in the business. Alternatively, the deceased shareholder may not have been active in the business, which was agreeable to the other shareholders because of the family relationship, but the same comfort does not extend to heirs of the inactive shareholder.  The original shareholders may want to continue to do business without input from inactive shareholders. At the same time, the deceased shareholder’s family may wish to remain a shareholder or have their shares purchased for an appropriate price.  

Shareholder agreements frequently provide that the remaining original shareholders or the company will purchase the deceased shareholder’s stock at fair market value.  There may be life insurance owned by the other shareholders or by the company, which must be used to purchase these shares. Take care with regard to the ownership of such life insurance to avoid the proceeds becoming income taxable to the recipient under the “transfer for value” provisions of the Internal Revenue Code.

Other agreements may provide that the remaining shareholders have the option, but not the requirement, to purchase the deceased shareholder’s stock. This sort of arrangement may also be funded with life insurance.

Disability of a shareholder

Accident or illness may prevent a shareholder from devoting full time and attention to the business. Whether the disability is severe enough to trigger a mandatory sale by the disabled shareholder to the other shareholders is a difficult question. For that reason, shareholder agreements should define what constitutes disability to minimize potential conflict between the disabled shareholder and the other shareholders. The period of disability that triggers a buyout or other provision should also be written into the agreement to avoid misunderstandings.

Often, shareholder agreements do not address partial disability, or the desire of a shareholder to devote less than full time to business endeavors, which has become increasingly common as shareholders partially retire, winter in warm climates or devote substantial time to charitable endeavors.  Many business owners find that they are unable to reach consensus on these issues, particularly in the case of an active participant who voluntarily reduces the time he or she devotes to the business.  The decision whether a particular circumstance should trigger a purchase requirement or option to purchase depends on what seems reasonable and who should have the power to make such a decision.  Consideration should be given to whether there should be an economic penalty by way of a reduced purchase price paid to a voluntarily departing shareholder.  Whether these decisions are ultimately memorialized in the shareholder agreement or not, initiating the discussion is important so that expectations are shared.

Desire of shareholder to transfer shares to children or trusts for children

Some agreements permit transfers to certain family members or trusts for their benefit without the approval of the other shareholders; other agreements require that all shareholders consent to all transfers so that the shareholders know and approve of the identity of their business partners. Some companies have voting and nonvoting shares and permit transfer only of nonvoting shares without approval of other shareholders.


While the parties to the shareholder agreement may agree that “fair market value” is the correct measure for the purchase price, the method to determine fair market value appropriate for the particular business in question must be considered, including whether fair market value for a minority interest should be subject to a valuation discount due to the nature of the interest. Some agreements require an independent appraisal of the business while others include a formula or require the parties to establish the value by vote each year.  Whatever methodology is used should be consistent with the valuation methodology used for gifts of shares and other transactions involving shares.

Tax consequences

The choice of whether the purchase will be a cross purchase by the other shareholders or a redemption by the company will have tax implications for the remaining shareholders, but the decision may be predetermined by what funds will be available to use for the purpose.  Take care to determine if a shareholder’s percentage ownership of the company would be diluted by structuring the agreement as a redemption rather than a cross-purchase arrangement.


Comprehensive succession planning must incorporate decisions about

  • control of the business
  • inactive family shareholders
  • family members who are employed by the business
  • the need to provide income for the senior family members
  • equitable treatment of children
  • the capability of the younger generation
  • the need to retain key employees
  • the family’s desire to continue to own and operate the business

The creation of a shareholder agreement is only one aspect of succession planning.  The younger generation may want an equity stake in the business, and at some point, control of the business.  This can be accomplished by a variety of gift and sale techniques, keeping in mind the stringent tax rules governing transfers between family members.  For example, promissory notes must carry a certain minimum interest set by the IRS (or else it will be imputed each year), and Chapter 14 of the Internal Revenue Code governs the valuation of transfers of certain, but not all, interests in a business.  The family will need to review the cash-flow consequences of all transfers, as well as the tax treatment of any such transfers, and review both in light of the family’s overall estate planning objectives. 

Business succession planning may also require addressing the motivation of key employees to assist the family shareholders and  preserve the value of the company.  The company’s lenders, suppliers and major customers will have a keen interest in knowing that the continuity of the business is assured. Finally, the plan should be reviewed periodically to be sure it continues to meet the objectives as intended.

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