What Is It?
Shareholder agreements are contracts that bind shareholders (partners in the case of a partnership) to a set of rules and restrictions regarding their ownership interest in a business. The rules and restrictions can be placed on shares of stock passed to your children as successors in interest as well, binding them to the terms of the agreement. Typically, the rules and restrictions apply to the sale or transfer of shares. The restrictions can grant you’re participating children the right to buy out your nonparticipating children if difficulties arise or if your nonparticipating children try to sell their shares outside of the family.
How to Do It
Establish Stock Restrictions
While you own the shares of your business, place restrictions on all shares of stock. If you are the sole shareholder, then there is no one else from whom you must seek consent.
Leave Stock to Your Children
Once done, leave your stock in equal shares to all of your children. Your children must accept the shares subject to the rules and restrictions. If your nonparticipating children interfere with business decisions or try to sell their stock outside of the family, your participating children will have the option to redeem the stock. Your participating children will end up with 100 percent of the business, and your nonparticipating children will end up with cash.
Tip: Exceptions to the buy-out provisions are often added to protect certain types of shareholders, such as other participating children and younger children who have not yet decided whether or not to work in the family business.
Example(s): Ted owns a home heating oil business. He has several children between the ages of 20 and 45. Some of his children work in the family business, and some don't. He wants to leave the business in equal shares to all of his children, but he wants to allow his participating children to remain in control. He places restrictions on the shares of stock, providing that the company can redeem any shareholder's stock, but not if they are employed by or making a living in the company, under the age of 25, or a full-time student. He then transfers the stock to his children in equal shares. The restrictions allow Ted's participating children to maintain control over the business. If any of Ted's nonparticipating children attempt to interfere with business operations, the business can redeem their shares. However, the business cannot redeem the shares of a sibling who is making a living in the family business. Similarly, the business must allow younger siblings to obtain an education and explore their career alternatives before attempting to redeem their stock.
Provides Children with Equal Opportunities to Participate In Business Ownership
An advantage to this planning solution is that you give all your children an equal opportunity to share in the ownership and growth of the family business. Provided your children can cooperate and agree on matters requiring shareholder approval, there may never be a need to redeem any shareholder's stock. However, if problems arise, you have installed a system for resolving the conflicts.
How Difficult Is It to Implement?
This planning solution is fairly easy to implement. You will need the assistance of a corporate attorney to draft and document the shareholder's agreement (rules and restrictions). You may also want to seek advice about what restrictions to impose, given your unique set of circumstances.
Creation of the shareholder agreement is not a taxable event. If you transfer the shares of stock during your lifetime, you may be able to avoid estate taxes on the property that is transferred. However, the transfers may be subject to gift taxes. The advice of a tax attorney should be sought.
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