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The 5 Ways A Partner Can Exit & How to Prepare for Each

How To Protect Your Company When A Partner Exits

There may be 50 ways to leave your lover, but when you’re a business owner, there are only five ways to leave your company.

If you value your company, you will have documentation that adequately addresses each of the following scenarios:

  1. Voluntary Termination
  2. Retirement (a form of voluntary termination)
  3. Involuntary Termination (you’re fired)
  4. Death
  5. Disability

Let’s look at each in detail:

 

EXIT OPTION #1: VOLUNTARY TERMINATION

Despite the harsh-sounding name, voluntary termination is the exit strategy everyone hopes for.

It means that the departing principal has left on his or her own terms. But the strategy only works if absent a sale of the entire company:

  1. The money you receive reflects the actual value of your stake in the company; and
  2. The company you’re leaving behind can afford to pay you

The best time to determine purchase price and payment method is before the occasion arises.

After all, once a principal has announced his decision to move on, the dynamics change and the negotiation, even if pleasant, becomes adversarial.

Conservatively speaking, there are over 100 ways to place a value on a company, from a hard-dollar value agreed in advance, through countless different formulae. There are just as many payment options.

Takeaway for Exit by Voluntary Termination

  • If there is more than one principal, there will be more than one idea of a good time horizon for departure.
  • Envisioning the circumstances of your departure and then planning the hard numbers to make it happen is one of the most vital things you can do for yourself and your business.
  • If trigger event, purchase price, the mechanics of the sale and payment method are not set down in writing and signed by every principal, your company is dangerously exposed.
  • People who plan on addressing this “tomorrow” instead of right now will fail 99% of the time because “tomorrow” never comes.

 

EXIT OPTION #2: RETIREMENT

Many, though by no means all, companies define the concept of retirement. Defining retirement recognizes the differences in value provided by someone who decides to leave within five years and someone who has stayed for 25 years.

In an effort to keep principals from cashing in early and leaving those remaining to figure out how to pay and replace them, companies will often discount the purchase price based upon departure date.

Let’s take the example of a company valued at $2,000,000.

The full value held by each 50% stockholder is $1,000,000. A Buy-Sell, Operating Agreement or Stockholders’ Agreement may provide that a departing 50% principal will receive 50% of his value if he leaves within five years and then proceed to add 5% per year until the full value is reached by year 20.

There is no question that people should be rewarded for a long, successful career successful career. There is also no question that nothing is served by a purchase price and payment schedule so generous as to bankrupt the company paying the note.

Takeaway for Exit by Retirement 

The best documents walk the line between competing interests and give both the departing and the remaining principals real and lasting value.

 

EXIT OPTIOIN #3: INVOLUNTARY TERMINATION

Hardly a week goes by when I do not meet with a group of principals to discuss starting a new company. Not one of those meetings featured an agreement among the principals that one or more of them could be fired.

Firing an owner is a touchy subject. But what if the worst happens?

What if, despite all odds, an owner develops a substance abuse problem down the road or simply, due to the onset of depression or otherwise, stops pulling his or her weight? Does one’s involvement in the company have to be “’til death do we part?”

In my experience, most companies elect to cross that bridge when they come to it, rather than take the risk that a group of partners can unfairly gang up on those with smaller holdings.

Takeaway for Exit by Involuntary Termination

There are ways in which a well-crafted Buy-Sell Agreement or Stockholders’ Agreement can address the involuntary departure of a principal.

Options include the selection of a predetermined objective arbitrator, a specific listing of job expectations/requirements and agreement as to objective performance metrics.

 

EXIT OPTION #4: DEATH

I always tell clients that death is the easiest trigger event to plan for.

First, unlike poor job performance or disability, it is objective. If you’re dead, people will know (with all due respect to that cinematic triumph that was Weekend at Bernie’s).

More importantly, companies and principals can choose from a variety of key-man life insurance products tailored to provide a mechanism under which a company will have the liquidity necessary to purchase the deceased principal’s stock from his or her estate immediately and for full value.

Through key-man life insurance and an agreement between the principals specifically drafted to make the best use of the company’s investment, the beneficiaries obtain the value of their family member’s investment while the company avoids bringing on a member of the deceased partner’s family as an unwanted and un-chosen stockholder.

Takeaway for Exit by Death

Care should be taken to consult with estate planning counsel, corporate counsel and the corporate accountant to ensure that the company and the principals adopt a plan for this exit scenario that serves all stakeholders well.

 

EXIT OPTION #5: DISABILITY

If death is the easiest trigger event to plan for, disability is the hardest.

If a principal is disabled, it stands to reason that:

  • The company will lose the services of that principal indefinitely and without warning.
  • The company will have to expend a significant amount of money to hire even a temporary replacement.
  • With increased medical costs, the principal and his family will be less able to absorb a financial downturn than at any other time in their lives.

The problem, for both the principal and the company, is that there are very few affordable disability insurance policies that offer lump sum benefits upon the onset of a disability.

Unlike key-man life insurance policies, which would enable an immediate buyout of the affected principal’s interest, disability policies will not enable the company to effectuate an immediate buyout of a significant portion of its value.

Takeaway for Exit by Disability

A balance must usually be found between the disabled principal’s need for money and the capital required by the company to hire a new principal and continue operations. 

Many corporate agreements provide that: 

  • The company is required to repurchase the holding of a disabled principal, if offered.
  • The purchase price for the principal’s stock will be 100% of its value.
  • The payment term will be extended, perhaps up to 15 years, to enable the company to recover and continue operations.

FINAL TAKEAWAY

As a principal, it’s important to ask yourself:

Is my company protected from each of these partner exit scenarios?

More specifically, ask:

Does my company have documentation that adequately addresses the five scenarios?

If not, there’s no better time to act than now.

In fact, now is the only time that makes smart business sense.

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