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The Shareholders Agreement

Many family business owners declare, "I own, therefore I manage." It's strange how the ownership and management issues get entangled like this, especially at the next generation stage. People who have jet planes don't say, "I own, therefore I'm the pilot!"

The shareholders agreement is supposed to be the place to address matters of ownership. But the shareholder discussion often doesn't even address the inalienable right of owners to work in the firm, much less the numerous other landmines in the battlefield of ownership.

Every family partnership should include an agreement that spells out what it means to be an owner: the definition of shareholder versus management concerns, as well as the prerequisites, obligations, rights and conditions of ownership.

Shareholders agreements need to address a definite list of topics under these headings, some of which I'll touch on later. But from a family perspective, it's important to understand why these discussions sometimes run into snags.

The first impulse is to blame greed – everyone else's, that is. But in a family business, it's often more complicated than that. The problem is that many family shareholders don't recognize that their fellow owners can legitimately have conflicting interests that are exacerbated by family history and relationships.

I recently met a second-generation family that demonstrates these diverse viewpoints. Four siblings equally inherited the firm from their parents. The eldest son runs the business and believes only he knows how to lead the business to prosperity. He has teenage children. His sister is divorced, has no children and would like extra income. A second brother does not work in the business, but would his children to participate if they wish. The youngest son works in the business, has young children and plans to stay for the long haul.

Can you imagine drawing up a buy-sell agreement and expecting it to help these four people – each with a valid but divergent interest in the business – live and work together? Without considering their ultimate intentions, it's nothing but an instruction booklet on how to carve up the company.

The four points of view in this real family are typical of the main "roles" that a shareholders agreement must satisfy: owner-manager, investor, inheritor and steward.

In shareholder negotiations, the family's business lawyers and I try to clarify the role or roles that each member plays. Once we understand their relationship to each other and to the business, we can usually get each to be more specific about what they would like the shareholders agreement to do. From there, it is a matter of finding the common ground – ensuring effective decision-making – and deciding how to govern the areas that are in dispute.

Other Hot Potatoes for the Shareholders Agreement:

  • How are ownership and management decisions defined? Are key ownership decisions made by shareholders, directors or a combination of both, and do they require a percentage vote other than a simple majority? Will any shareholders have a veto power?
  • How many inactive shareholders can sit on the board, if any?
  • Can spouses own or inherit family shares? Who else cannot inherit shares?
  • When can transfers be made, and can they be forced?
  • How will financing decisions be made?

But first, our four shareholders will have to step over some hot coals – the burning questions of every shareholders agreement. Let's see how different types of shareholders see things from entirely different perspectives:

Who can work in the family firm? Inheritors will want any owner to be able to work in the firm if they wish. Investors want only competent family members who can add to growth and profitability. Stewards agree with investors but usually want a more structured regimen for entry, staying and exiting. Owner-managers believe employment is an operational issue for senior management (usually one person) to decide.

Who can hold stock? The inheritor wants everyone to own shares, while the owner-manager believes shares should be held only by those who are active in the firm. Actives usually argue that good management needs a manageable ownership group, while inactives hold that management decisions can be separated from the benefits of ownership.

How will the buy-sell section be structured? The investor argues for an open buy-sell arrangement giving family members the right of first refusal before a sale to a third party. The steward wants to keep the shares in the family and lobbies for a majority – even a large majority – vote among shareholders before allowing a third-party sale. At the third-generation stage, everyone might wish to establish an internal stock market so that no one feels locked in.

How will disputes be resolved? Owners and investors who suggest a shotgun clause – where one shareholder can make an offer to buy out partners but must sell at the same price if the partners invoke the shotgun – are often opposed by stewards and young, active shareholders who could not hope to buy out their family members.

All kinds of other ownership issues come up – each of them with a similarly molten core that can spill over at any time. In every case, it's fascinating to observe how diverse opinions spring from different interest groups, whether it's about use of funds, who can inherit shares or how shareholders who are active managers should be compensated.

So if you're stuck with your shareholders agreement, take a step back and discuss what everyone would like to happen over the next couple of generations. You'll be surprised how it can sift out what's impossible or unacceptable in your agreement.

And if you or your family partners find difficulty coexisting with one another's desires and ambitions for the business, maybe you can at least find a way to allow one another to leave gracefully.

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