One of the supposed benefits of Arbitration is the decreased costs in comparison to traditional litigation. The arbitration process is more compact and is briefer, and attempts to dispense with extended discovery (in fact, often opting for no discovery at all), thus reducing the costs of numerous lawyer's hours, court reporter's hours, deposition transcripts, etc. While in the case I just finished, it is true less money was spent on attorneys and depositions, the other costs that were incurred at the very least were equal if not greater than traditional litigation fees.
First, unlike in traditional litigation, the parties are required to pay the "judge" (i.e., the Arbitrator), whose fees per hour will rival or even exceed his attorney counterparts. While from a purely abstract libertarian perspective, I like the idea that the parties to a dispute pay the full costs of the legal proceedings rather than burdening the taxpayers through tax-funded courts and personnel, as a practical matter, this can sometimes end up being more costly for a client than simply going through the state- or federally-funded litigation process.
Second, in my specific case, the costs were trebled through legal maneuvering from the other party's attorneys. The case at issue involved an owner/contractor disagreement, involving three different properties the contract was constructing for my client. Instead of filing one lawsuit or one arbitration, the contractor filed three. In traditional litigation, a judge likely would have combined all three into one case for the sake of judicial efficiency. In this case, however, the arbitrator assigned to rule just on this motion (whom had to be paid separately) ruled against it. That meant my client was required to ante up money for three different arbitrators, assigned to three distinct cases, when one paid arbitrator could have decided it in about the time it would cost to hear one case. It was an interesting tactic, because I believe my client was more able to absorb the costs than his opponent.
We estimated that the case, if consolidated, would take about a week to try, but unfortunately, because each arbitrator would be hearing his particular case anew, each time we'd need to spend a few days simply laying out the facts. Instead of paying for one week's arbitration, we would now pay for approximately three. Do the math on arbitrators who charge about $300 per hour, assume eight hour days, times 21 days. It's not cheap. Now add in attorneys for each side who will also be litigating for three weeks.
Finally, even though trial litigation can be expensive, the reality is many cases never make it that far--not because of settlement (which of course happens often)--but because the case is disposed of earlier by motions. I've litigated numerous cases for this particular client, but more than half of them never made it to trial because I got them dismissed early on. Because the arbitration procedure does not typically rule on such dispositive motions, and simply lets it go to a hearing (and if you think about it, it's in the arbitrator's financial self-interest to keep the case going so he can be paid), my client would have spent far more if those cases had been arbitrated than it did by litigating them.
Although I am sure each arbitration varies on its merits, my experience thus far is that arbitration has not been less expensive than litigation, and in fact has been more so.
Sabtu, 26 April 2008
Minggu, 20 April 2008
Arbitration and Arbitration Clauses in Contracts -- Overview
Many of my more sophisticated clients, for whom I draw contracts, commonly ask if we should put in a provision to require "Binding Arbitration" in the event of a legal dispute.
The idea, in theory, is a good one. Arbitration, it is said, will reduce the legal costs otherwise incurred in court; will produce fairer results less dependent on technicalities and based more on the merits and equities; and will resolve matters more quickly.
I'd sat on the sidelines for a long time and advised against them, primarily from cases I had watched and from my own personal convictions that I was able to use the mechanics of the legal system to obtain a more favorable result for most of my clients.
However, I finally got the benefit of putting Arbitration to the test, recently, when a client of mine got into a dispute with a large commercial contractor over several projects. Each project was governed by a separate contract, each of which provided for binding arbitration in the event of a dispute, and the contractor, pursuant to his rights, demanded binding arbitration. Because the contractor's attorney was a litigator who specialized in construction litigation, and because I did not want my first experience in arbitration to be against an experienced specialist when hundreds of thousands of dollars were on the line, I associated a colleage of mine who was also a construction litigation specialist.
Through the process, I got the opportunity to watch how binding arbitration worked, to see its advantages and disadvantages in action, and now feel more qualified than before to speak about arbitration.
First, my opinion: putting binding arbitration clauses in contracts is still, in my opinion, a bad idea. Arbitration, in my experience, does not adequately deliver on its promised benefits (costs and fairness), while subjecting its participants to a procedure and to rulings that are only loosely bound by a rule of law and, for the most part, are non-appealable.
Next, in the upcoming articles, I will discuss the structure of binding arbitration, its alleged benefits and its drawbacks, and allow the reader to draw his own conclusions. Stay tuned....
The idea, in theory, is a good one. Arbitration, it is said, will reduce the legal costs otherwise incurred in court; will produce fairer results less dependent on technicalities and based more on the merits and equities; and will resolve matters more quickly.
I'd sat on the sidelines for a long time and advised against them, primarily from cases I had watched and from my own personal convictions that I was able to use the mechanics of the legal system to obtain a more favorable result for most of my clients.
However, I finally got the benefit of putting Arbitration to the test, recently, when a client of mine got into a dispute with a large commercial contractor over several projects. Each project was governed by a separate contract, each of which provided for binding arbitration in the event of a dispute, and the contractor, pursuant to his rights, demanded binding arbitration. Because the contractor's attorney was a litigator who specialized in construction litigation, and because I did not want my first experience in arbitration to be against an experienced specialist when hundreds of thousands of dollars were on the line, I associated a colleage of mine who was also a construction litigation specialist.
Through the process, I got the opportunity to watch how binding arbitration worked, to see its advantages and disadvantages in action, and now feel more qualified than before to speak about arbitration.
First, my opinion: putting binding arbitration clauses in contracts is still, in my opinion, a bad idea. Arbitration, in my experience, does not adequately deliver on its promised benefits (costs and fairness), while subjecting its participants to a procedure and to rulings that are only loosely bound by a rule of law and, for the most part, are non-appealable.
Next, in the upcoming articles, I will discuss the structure of binding arbitration, its alleged benefits and its drawbacks, and allow the reader to draw his own conclusions. Stay tuned....
Sabtu, 05 April 2008
Reader's questions about minority shareholders
A reader recently wrote a very good question about minority shareholders, and I thought the situation would be worthy of posting. Here is the question, and answer, with permission.
"Hi,
I read your article about minority shareholders. I got an offer to become a shareholder of a small company without paying anything, just because I have been working for them for a period of time.
However, my plans are to go to grad school and then after a year or two look for a position in a large company. Can I then go to work for another company if now I've agreed to become a shareholder of the small company that is just starting? If not, can I, after a year or two, tell that small company that I don't want to be a shareholder anymore? I'm being told by the other shareholders that everything will need to be confidential, so I don't know if my husband and I can show the shareholder agreement to a lawyer."
--------------
First, understand that I am only licensed to practice in North Carolina, and this does not constitute legal advice.
Second, at least in North Carolina, but usually in other states, it is a general industry practice that any agreements which would involve you personally but are labelled "confidential" can still be studied, shared, reviewed by legal counsel before you decide to sign it. Still, the best practice is to let the others know you'd like your personal attorney to review the documents.
Finally, there are two things which may prevent you from joining a big company while still a shareholder of the smaller one. The first is that (assuming their businesses are similar), if you're involved with the smaller company, you owe a duty of loyalty to that smaller venture. If you go to another company, you are not able to use your best efforts for the smaller company. In fact, your actions may go further and violate specific provisions of your shareholders' agreement.
The second issue is also a serious one: what if you just give up your stock rights and leave the company; will that solve everything? There still may be a problem if the remaining shareholders allege that you are using proprietary or confidential information you obtained while a shareholder in the small company. This may specifically violate terms of your shareholder's agreement (which may contain a non-disclosure provision) or it may violate your state's common law rules (i.e., civil rules created by caselaw) regarding what information from your former employer/partnership/venture/etc. that you can use once you leave.
The best thing you can do? Be upfront with the other shareholders, and negotiate a provision that, while protecting their interests, allows you the freedom one day to leave for bigger things: e.g., perhaps an agreement that allows you to leave and join a competing business, but provides that the remaining shareholders can buy out your interest at a fair price (the determination of which would be a subject in itself). If they won't agree to this, both sides are already on notice that there will be a potential conflict in the future--so why buy into it? Either walk away, or understand you may have a fight on your hands when you leave.
"Hi,
I read your article about minority shareholders. I got an offer to become a shareholder of a small company without paying anything, just because I have been working for them for a period of time.
However, my plans are to go to grad school and then after a year or two look for a position in a large company. Can I then go to work for another company if now I've agreed to become a shareholder of the small company that is just starting? If not, can I, after a year or two, tell that small company that I don't want to be a shareholder anymore? I'm being told by the other shareholders that everything will need to be confidential, so I don't know if my husband and I can show the shareholder agreement to a lawyer."
--------------
First, understand that I am only licensed to practice in North Carolina, and this does not constitute legal advice.
Second, at least in North Carolina, but usually in other states, it is a general industry practice that any agreements which would involve you personally but are labelled "confidential" can still be studied, shared, reviewed by legal counsel before you decide to sign it. Still, the best practice is to let the others know you'd like your personal attorney to review the documents.
Finally, there are two things which may prevent you from joining a big company while still a shareholder of the smaller one. The first is that (assuming their businesses are similar), if you're involved with the smaller company, you owe a duty of loyalty to that smaller venture. If you go to another company, you are not able to use your best efforts for the smaller company. In fact, your actions may go further and violate specific provisions of your shareholders' agreement.
The second issue is also a serious one: what if you just give up your stock rights and leave the company; will that solve everything? There still may be a problem if the remaining shareholders allege that you are using proprietary or confidential information you obtained while a shareholder in the small company. This may specifically violate terms of your shareholder's agreement (which may contain a non-disclosure provision) or it may violate your state's common law rules (i.e., civil rules created by caselaw) regarding what information from your former employer/partnership/venture/etc. that you can use once you leave.
The best thing you can do? Be upfront with the other shareholders, and negotiate a provision that, while protecting their interests, allows you the freedom one day to leave for bigger things: e.g., perhaps an agreement that allows you to leave and join a competing business, but provides that the remaining shareholders can buy out your interest at a fair price (the determination of which would be a subject in itself). If they won't agree to this, both sides are already on notice that there will be a potential conflict in the future--so why buy into it? Either walk away, or understand you may have a fight on your hands when you leave.
Sabtu, 15 Maret 2008
Purchasing a Business and using Brokers
On a weekly basis I represent individuals who are buying and selling small businesses. Occasionally, these clients employ the services of a business broker who, like a real estate broker, brokers the sale of the business, often representing the interests of both buyers and sellers in setting up a deal.
I've met some very knowledgeable brokers who have found niche specialties--such as one with whom I worked last month who only brokers the sale and purchase of pharmacies. However, just as with real estate brokers, there are very good ones, and then there are those who add little value to the deal other than putting a willing buyer with a willing seller.
The purpose of this post is not to discourage business buyers or sellers from using a business broker (after all, the broker can sometimes put you in touch with another party and connect you in ways you could not do yourself). However, there are at least two areas in which you need to be careful and protect yourself when using a business broker.
1. Do not let the business broker draw up your contract. Going back to the real estate analogy, in residential (and often commercial) real estate transactions, the broker often draws up the contract to be signed by the parties. However, these contracts have often been developed over time and adopted by your state's realtors association as well as the state bar association. These contracts have been used and revised enough that they can fairly well cover the exigencies involved with real estate.
A business sale, however, is far more complicated and multi-faceted, and does not lend itself well to a one-size-fits-all form contract. Furthermore, a business broker (unless he is a specialist broker, and often even not then) will not have sufficient legal understanding of all of the issues which are involved (and the laws governing them), to adequately protect the buyer and seller in a business sale contract.
Take, for example, a form contract I recently reviewed for a client in the construction industry. He'd agreed to sell his business for a price certain, and the buyer had agreed to purchase my client's building, within 60 days of the business sale, for an additional price. The parties had also agreed in theory--as is often the case--that my client would stay on as a consultant on an as-needed basis for a certain length of time. Pretty simple, isn't it? Perhaps, but the form contract drafted by the broker left some glaring holes:
1. First, though the broker was only responsible for listing the business (and thus receiving a commission on the business), he'd written the real estate sale into the form contract such that the broker would receive a 10 percent commission on the sale of the real estate as well--more than doubling what his commission would have been!
2. The purchaser wanted my client to sign a 100-mile radius non-compete for three years, which the broker had written into the form contract. However, such a wide-ranging non-compete would likely not be upheld in the state of North Carolina. The broker didn't know this.
3. The contract provided that my client would work as a consultant, but didn't specify his hours or his rate of pay.
In addition, the broker attempted to steer both parties to one attorney who would close the deal for both of them (more on that later). By the time my client came to me, the two parties were arguing over all the gaps which had been left in the contract but were now needing to be filled in.
A broker's form contract for the sale of the business is inadequate unless it is to operate merely as a non-binding letter of intent which just ensures the parties, in theory, have an agreement.
A well-written business purchase agreement is large, often contains lots of legalese, and will sometimes take quite a bit of negotiation. However, the beauty of it is that, once it is signed, the parties know exactly what the terms of the deal are, and now can move forward to closing with a clear understanding of what the seller is selling and the purchaser is purchasing. In the last two closings I handled, the actual "closing" of the business, in the attorney's office, took about 30 minutes each!
A good purchase agreement should be clear on the details, and, once signed, allow the purchaser to move forward with his due diligence and the seller to prepare for the conveyance of his business without having to haggle over details.
In the case above, the parties were able to sign an agreement quickly, but over the ensuing months of trying to fill in the details, have now become somewhat at odds with each other. This doesn't need to happen.
2. In a business purchase or sale, each side should have his own attorney. Often, brokers attempt to funnel both buyer and seller to a supposed "neutral" attorney, who simply draws up the conveyance papers based upon what was agreed upon in the form contract. Often, I've found, these forms state something like, "You should hire your own attorney to review these documents," but in practice, my clients tell me that the broker has discouraged them from doing this, saying one lawyer is enough.
Sure, it sounds self-serving, but in a business transaction each side should have his own counsel. In many real estate transactions, one lawyer can adequately (and, at least in North Carolina, legally) represent both sides. However, a business sale is much more complicated.
In the example above, the attorney recommended by the broker was good and was honest. In fact, he was so honest that he felt he should only represent the purchaser's interests and not try to represent both sides. My client came to me with proposed closing documents that included:
1. A consultation agreement requiring him to work at the purchaser's will for less than half of his normal hourly pay rate;
2. A property lease that allowed the purchaser to lease--with no obligation to purchase--the seller's real estate, notwithstanding the provisions of their form contract.
3. A non-compete that was so overbroad and vague, it would have prevented my client from getting work that was realistically not in competition with the purchaser's acquired business.
Furthermore, if both parties go to a supposedly "neutral" attorney, what is that attorney's obligation to point out (or even correct) legal flaws created in the original form contract? In this case, the hired attorney pointed out that the originally agreed-upon non-compete was overly broad and unenforceable in our state. But what if he had not? Would he have overreached against the seller? Or would he have been negligent and committed malpractice as to the purchaser, who, if he needed to enforce the non-compete, would have been unable to do so?
In sum, though business brokers are a valuable source of information when buying and selling your business, you'd be best served to hire counsel to advise you through the process.
If you need help or representation in buying or selling your business, you can set up a consultation with me by calling 704-735-0483.
I've met some very knowledgeable brokers who have found niche specialties--such as one with whom I worked last month who only brokers the sale and purchase of pharmacies. However, just as with real estate brokers, there are very good ones, and then there are those who add little value to the deal other than putting a willing buyer with a willing seller.
The purpose of this post is not to discourage business buyers or sellers from using a business broker (after all, the broker can sometimes put you in touch with another party and connect you in ways you could not do yourself). However, there are at least two areas in which you need to be careful and protect yourself when using a business broker.
1. Do not let the business broker draw up your contract. Going back to the real estate analogy, in residential (and often commercial) real estate transactions, the broker often draws up the contract to be signed by the parties. However, these contracts have often been developed over time and adopted by your state's realtors association as well as the state bar association. These contracts have been used and revised enough that they can fairly well cover the exigencies involved with real estate.
A business sale, however, is far more complicated and multi-faceted, and does not lend itself well to a one-size-fits-all form contract. Furthermore, a business broker (unless he is a specialist broker, and often even not then) will not have sufficient legal understanding of all of the issues which are involved (and the laws governing them), to adequately protect the buyer and seller in a business sale contract.
Take, for example, a form contract I recently reviewed for a client in the construction industry. He'd agreed to sell his business for a price certain, and the buyer had agreed to purchase my client's building, within 60 days of the business sale, for an additional price. The parties had also agreed in theory--as is often the case--that my client would stay on as a consultant on an as-needed basis for a certain length of time. Pretty simple, isn't it? Perhaps, but the form contract drafted by the broker left some glaring holes:
1. First, though the broker was only responsible for listing the business (and thus receiving a commission on the business), he'd written the real estate sale into the form contract such that the broker would receive a 10 percent commission on the sale of the real estate as well--more than doubling what his commission would have been!
2. The purchaser wanted my client to sign a 100-mile radius non-compete for three years, which the broker had written into the form contract. However, such a wide-ranging non-compete would likely not be upheld in the state of North Carolina. The broker didn't know this.
3. The contract provided that my client would work as a consultant, but didn't specify his hours or his rate of pay.
In addition, the broker attempted to steer both parties to one attorney who would close the deal for both of them (more on that later). By the time my client came to me, the two parties were arguing over all the gaps which had been left in the contract but were now needing to be filled in.
A broker's form contract for the sale of the business is inadequate unless it is to operate merely as a non-binding letter of intent which just ensures the parties, in theory, have an agreement.
A well-written business purchase agreement is large, often contains lots of legalese, and will sometimes take quite a bit of negotiation. However, the beauty of it is that, once it is signed, the parties know exactly what the terms of the deal are, and now can move forward to closing with a clear understanding of what the seller is selling and the purchaser is purchasing. In the last two closings I handled, the actual "closing" of the business, in the attorney's office, took about 30 minutes each!
A good purchase agreement should be clear on the details, and, once signed, allow the purchaser to move forward with his due diligence and the seller to prepare for the conveyance of his business without having to haggle over details.
In the case above, the parties were able to sign an agreement quickly, but over the ensuing months of trying to fill in the details, have now become somewhat at odds with each other. This doesn't need to happen.
2. In a business purchase or sale, each side should have his own attorney. Often, brokers attempt to funnel both buyer and seller to a supposed "neutral" attorney, who simply draws up the conveyance papers based upon what was agreed upon in the form contract. Often, I've found, these forms state something like, "You should hire your own attorney to review these documents," but in practice, my clients tell me that the broker has discouraged them from doing this, saying one lawyer is enough.
Sure, it sounds self-serving, but in a business transaction each side should have his own counsel. In many real estate transactions, one lawyer can adequately (and, at least in North Carolina, legally) represent both sides. However, a business sale is much more complicated.
In the example above, the attorney recommended by the broker was good and was honest. In fact, he was so honest that he felt he should only represent the purchaser's interests and not try to represent both sides. My client came to me with proposed closing documents that included:
1. A consultation agreement requiring him to work at the purchaser's will for less than half of his normal hourly pay rate;
2. A property lease that allowed the purchaser to lease--with no obligation to purchase--the seller's real estate, notwithstanding the provisions of their form contract.
3. A non-compete that was so overbroad and vague, it would have prevented my client from getting work that was realistically not in competition with the purchaser's acquired business.
Furthermore, if both parties go to a supposedly "neutral" attorney, what is that attorney's obligation to point out (or even correct) legal flaws created in the original form contract? In this case, the hired attorney pointed out that the originally agreed-upon non-compete was overly broad and unenforceable in our state. But what if he had not? Would he have overreached against the seller? Or would he have been negligent and committed malpractice as to the purchaser, who, if he needed to enforce the non-compete, would have been unable to do so?
In sum, though business brokers are a valuable source of information when buying and selling your business, you'd be best served to hire counsel to advise you through the process.
If you need help or representation in buying or selling your business, you can set up a consultation with me by calling 704-735-0483.
Sabtu, 23 Februari 2008
The Family Business -- Finale
In the last few weeks, I've been discussing what to do with your family business, specifically focusing on the issues inherent to passing the business on to your family members. Today I'll go through a few of the remaining issues to consider.
1. (If you're selling) Should you sell for cash to your family or owner-finance? As a practical matter, your family will likely be unable to pay for the business unless you can owner finance. If you really want to cash out, you'll probably need to find an arms-length third party buyer.
2. Should you stay or should you go? One issue to consider is, when you convey your business to your family, should you request or offer to stay on in some limited capacity (e.g., as a part-time employee, a consultant, etc.)? When selling your family business to an outsider, the buyer usually should have a desire to keep you on, if for no other reason than to (1) help retain the business's good will and (2) create a smoother transition period.
Family businesses offer different dynamics, however; no matter how much you love your family, can y'all work together?
Anecdotally, from my past experiences, most parents do not stay on after conveying their business to their children. I suspect that, by the time they hand it over, they're ready to see if the business can sink or float on their children's efforts, and quite frankly know that they would drive themselves (and their children) crazy if they hang on and offer advice. A small exception to this, however, is that some parents I've seen stay on as "consultants" (usually, at most a nominal title) so that they're able to stay "employed" by the business and keep some type of needed medical insurance.
3. Anything else I should consider? Most likely, but your business is special, and it's unique to you. One of the joys of my practice is that I've learned the quirks and specialties of numerous small business, as well as the idiosyncracies of each of their individual owners. No two businesses--even within the same industry--are alike, so you need to make sure you're represented by competent tax and legal professionals. Preparing a succession plan for your business will only happen once in your lifetime--make sure it's treated importantly. If you would like to talk further about your specific situation, contact me at 704-735-0483, and set up an appointment.
1. (If you're selling) Should you sell for cash to your family or owner-finance? As a practical matter, your family will likely be unable to pay for the business unless you can owner finance. If you really want to cash out, you'll probably need to find an arms-length third party buyer.
2. Should you stay or should you go? One issue to consider is, when you convey your business to your family, should you request or offer to stay on in some limited capacity (e.g., as a part-time employee, a consultant, etc.)? When selling your family business to an outsider, the buyer usually should have a desire to keep you on, if for no other reason than to (1) help retain the business's good will and (2) create a smoother transition period.
Family businesses offer different dynamics, however; no matter how much you love your family, can y'all work together?
Anecdotally, from my past experiences, most parents do not stay on after conveying their business to their children. I suspect that, by the time they hand it over, they're ready to see if the business can sink or float on their children's efforts, and quite frankly know that they would drive themselves (and their children) crazy if they hang on and offer advice. A small exception to this, however, is that some parents I've seen stay on as "consultants" (usually, at most a nominal title) so that they're able to stay "employed" by the business and keep some type of needed medical insurance.
3. Anything else I should consider? Most likely, but your business is special, and it's unique to you. One of the joys of my practice is that I've learned the quirks and specialties of numerous small business, as well as the idiosyncracies of each of their individual owners. No two businesses--even within the same industry--are alike, so you need to make sure you're represented by competent tax and legal professionals. Preparing a succession plan for your business will only happen once in your lifetime--make sure it's treated importantly. If you would like to talk further about your specific situation, contact me at 704-735-0483, and set up an appointment.
Sabtu, 16 Februari 2008
The Family Business, Part 3: Give or Sell?
I've been blogging in the past few weeks about the "family business"--i.e., that small business set up by an entrepeneur, and nourished to fruition--and issues that any successful small business owner should consider when getting closer to retirement age.
First, I discussed the issue of whether the family members had the desire or even the ability to carry on the family business, because in my anecdotal experience, fewer than half of entrepeneurs have families who are both willing and able to carry on the family business.
But for this week, let's assume your family falls into that category. If a member of you family has both the desire--and the ability--to keep the family business running, what you should consider next? Based upon my experience with family businesses, I would suggest that you next consider whether you should sell your business to your family, or whether you should give your business to your family.
The average non-entrepeneur I'd hazard would be be a bit aghast at the idea of selling his business to his family. The average non-entrepeneur believes that his or her job should be to share his wealth with his children, to the extent possible. However, entrepeneurs--many of whom came by success with some difficulty--are more open to the idea. There are many non-legal reasons why perhaps you should consider the issue of sale versus gift (i.e., anything worked for is much sweeter, in an entrepeneur's mind), but I'm going to focus on legal and tax implications for considering this question. As always, there is no generally right or wrong answer--the issue needs to be carefully considered, with the help of both tax and legal counsel. Here are just three things to think about when considering this issue.
1. ESTATE PLANNING. One thing to consider is the tax consequences of your conveyance to your children (both income and estate). Chances are, the actual "book" value of your company (i.e. the value of its hard assets) is much less than you'd actually accept for it if you sold it on the open market. Perhaps, if you own a golf course, your land is worth $1 million, and your equipment is worth another $1 million. However, if your golf course is wildly successful, you might not be willing to sell it for less than $6 million (this value added to the hard value is what is commonly referred to as "good will"). Sometimes, tax lawyers or accountants will advise a sale of the company to children in order to reduce estate taxes.
Using the above example, even if you aren't willing to part with your golf course for less than $6 million, suppose your tax advisor tells you that--since you've never received an offer for your company and it has a book value of $2 million--you could legitimately sell it for $2 million to your children. You have effectively--and legally--gifted $4 million to your children without having to pay estate taxes.
Again using the above example, had you gifted your children the golf course with a book value of $2 million, that would not, at this time, create an estate tax consequence, but if you died leaving them much more property, you might very well create an estate tax burden for them (the subject of estate taxes is too lengthy and complicated to go into at depth; if you have any questions, please contact me and I will refer you to an excellent tax attorney).
Therefore, arms-length sales are sometimes an effective means by which to reduce your estate tax burden before you die.
2. REDUCING INCOME TAXES. Sometimes, a sale versus a gift can reduce the income taxes your family may pay on its property in the long run. This is especially important if you are considering, in the short term, a sale of the business to an outside investor. Using the golf course example, again, let's say that, when all the equipment and land were purchased, their book value was $300,000. If you were to sell the business right now for $6 million, you would pay taxes on your gain (Sales price of $6 million, minus original basis of $300,000 = taxes on $5.7 million). If, however, you could in good faith sell your family business to your family for its book value ($2 million, in my example), your family would pay taxes on the gain of $6 million minus $2 million, which would reduce its taxable basis. (Understand that I'm using simplistic examples: a tax advisor may tell you to hold your business until you die so that your children could get a "stepped up basis"--in this case, $6 million; so please understand there is no one formula that fits all).
3. SELLING YOUR BUSINESS TO FAMILY CAN PROVIDE YOU INCOME. Let's say that you family is willing and able to run you business, and your tax advisor believes that an arms-length book-value transaction is the best idea for your business. There's another good reason to sell your business versus giving it away: it can provide a steady stream of income. First, an assumption: almost no sale of family businesses to another family member involves an actual cash purchase. Instead, they typically involve selller financing. In addition to providing you tax savings, selling to your family can provide you a steady stream of income in the form of seller financing payments back to you on a promissory note. This is often important anyway, but if I am representing the spouse of a deceased entrepeneur, often this is even more important. Selling to the children, and owner-financing the sale, can provide to the seller a steady stream of income during the seller's golden years, while at the same time giving his or her children tax benefits and a leg up in this world.
If you have any questions, please call my office and set up an appointment at 704-735-0483.
First, I discussed the issue of whether the family members had the desire or even the ability to carry on the family business, because in my anecdotal experience, fewer than half of entrepeneurs have families who are both willing and able to carry on the family business.
But for this week, let's assume your family falls into that category. If a member of you family has both the desire--and the ability--to keep the family business running, what you should consider next? Based upon my experience with family businesses, I would suggest that you next consider whether you should sell your business to your family, or whether you should give your business to your family.
The average non-entrepeneur I'd hazard would be be a bit aghast at the idea of selling his business to his family. The average non-entrepeneur believes that his or her job should be to share his wealth with his children, to the extent possible. However, entrepeneurs--many of whom came by success with some difficulty--are more open to the idea. There are many non-legal reasons why perhaps you should consider the issue of sale versus gift (i.e., anything worked for is much sweeter, in an entrepeneur's mind), but I'm going to focus on legal and tax implications for considering this question. As always, there is no generally right or wrong answer--the issue needs to be carefully considered, with the help of both tax and legal counsel. Here are just three things to think about when considering this issue.
1. ESTATE PLANNING. One thing to consider is the tax consequences of your conveyance to your children (both income and estate). Chances are, the actual "book" value of your company (i.e. the value of its hard assets) is much less than you'd actually accept for it if you sold it on the open market. Perhaps, if you own a golf course, your land is worth $1 million, and your equipment is worth another $1 million. However, if your golf course is wildly successful, you might not be willing to sell it for less than $6 million (this value added to the hard value is what is commonly referred to as "good will"). Sometimes, tax lawyers or accountants will advise a sale of the company to children in order to reduce estate taxes.
Using the above example, even if you aren't willing to part with your golf course for less than $6 million, suppose your tax advisor tells you that--since you've never received an offer for your company and it has a book value of $2 million--you could legitimately sell it for $2 million to your children. You have effectively--and legally--gifted $4 million to your children without having to pay estate taxes.
Again using the above example, had you gifted your children the golf course with a book value of $2 million, that would not, at this time, create an estate tax consequence, but if you died leaving them much more property, you might very well create an estate tax burden for them (the subject of estate taxes is too lengthy and complicated to go into at depth; if you have any questions, please contact me and I will refer you to an excellent tax attorney).
Therefore, arms-length sales are sometimes an effective means by which to reduce your estate tax burden before you die.
2. REDUCING INCOME TAXES. Sometimes, a sale versus a gift can reduce the income taxes your family may pay on its property in the long run. This is especially important if you are considering, in the short term, a sale of the business to an outside investor. Using the golf course example, again, let's say that, when all the equipment and land were purchased, their book value was $300,000. If you were to sell the business right now for $6 million, you would pay taxes on your gain (Sales price of $6 million, minus original basis of $300,000 = taxes on $5.7 million). If, however, you could in good faith sell your family business to your family for its book value ($2 million, in my example), your family would pay taxes on the gain of $6 million minus $2 million, which would reduce its taxable basis. (Understand that I'm using simplistic examples: a tax advisor may tell you to hold your business until you die so that your children could get a "stepped up basis"--in this case, $6 million; so please understand there is no one formula that fits all).
3. SELLING YOUR BUSINESS TO FAMILY CAN PROVIDE YOU INCOME. Let's say that you family is willing and able to run you business, and your tax advisor believes that an arms-length book-value transaction is the best idea for your business. There's another good reason to sell your business versus giving it away: it can provide a steady stream of income. First, an assumption: almost no sale of family businesses to another family member involves an actual cash purchase. Instead, they typically involve selller financing. In addition to providing you tax savings, selling to your family can provide you a steady stream of income in the form of seller financing payments back to you on a promissory note. This is often important anyway, but if I am representing the spouse of a deceased entrepeneur, often this is even more important. Selling to the children, and owner-financing the sale, can provide to the seller a steady stream of income during the seller's golden years, while at the same time giving his or her children tax benefits and a leg up in this world.
If you have any questions, please call my office and set up an appointment at 704-735-0483.
Jumat, 08 Februari 2008
The Family Business, Part 2
When considering a succession plan for your family business, start with one of the most basic questions: who should succeed to your business in the event of your passing? A basic question, to be sure, but before you start planning your business plan wrap up, you need to determine whether it should descend to your family or not?
If you are like most entrepeneurs, you'll typically want your family to share in the successes of your business, but you may need to decide whether they should take on your business, or whether you should just pass to them the fruits of your business. When thinking about this, ask yourself these questions:
1. Does your family have the desire? First, ask yourself: does your family even want to continue your business? I've never done a formal survey, but anecdotally, I'd estimate that no more than half of the entrepeneurs I represent has families who even desire to take over the business. Often, the children have watched their parents sacrifice their private lives and time with family to build a successful business, and the children determine that they don't want to live their lives that way. I also suspect that for many of these children, who have enjoyed the financial fruits of their parents' labor, they subconsciously disconnect the labor necessary obtain those benefits. What do I mean? I've seen numerous children of successful entrepeneurs decide to work in lower-paying jobs--becoming teachers, social workers, and other idealistic professions. Some of these, I believe, decide to follow a calling such as this because in the back of their minds they know that they have their parents' financial resources to rely on.
If you're like most of my entrepeneur clients, your children have enjoyed the benefits of you owning the business: but do they want to own the business?
2. Does your family have the ability? Even if your family members do desire to take over the business, ask yourself this brutally honest question: do they have the ability to successfully continue (and even expand) the business you worked hard to create? Anecdotally, again, I've found that in more than half the cases, if a family member actually desires to continue the family business, that family member probably also has the ability. You've ingrained into him or her the work ethic necessary, and your family hopefully will share many of your same values that helped make your business a success. However, your family's ability is not a given. Just because you have a brilliant medical practice does not mean that your child can share that gift you have. Make an honest appraisal of your family members and your business. Does your business require mainly hard work and a certain ethic? If so, your child's desire to continue the business may see him through. Does it also contain certain talents or gifts that most people don't possess? Consider it more closely, then.
3. What do you do when there are multiple family members? I've been writing this article almost as if you only have one child, but the average family, of course, will have two or three children. This could bring multiple complications--all of which can be overcome with planning, but which need to be considered. I've seen all of the following issues:
--A brother and sister both want to run the family business, but don't get along.
--There are three brothers, two already in the family business, but one who is much younger and a minor.
--One child has always been in the business, and the other has never had anything to do with it, and the parent is trying to figure up how to divide his estate fairly between both of them.
None of the issues I have mentioned should keep you from making a succession plan with your family business. To the contrary, they are matters to be considered, and, with good planning from an attorney, an accountant, and perhaps even an investment advisor, they can all be taken into consideration when creating a successful plan regarding your business.
If you are like most entrepeneurs, you'll typically want your family to share in the successes of your business, but you may need to decide whether they should take on your business, or whether you should just pass to them the fruits of your business. When thinking about this, ask yourself these questions:
1. Does your family have the desire? First, ask yourself: does your family even want to continue your business? I've never done a formal survey, but anecdotally, I'd estimate that no more than half of the entrepeneurs I represent has families who even desire to take over the business. Often, the children have watched their parents sacrifice their private lives and time with family to build a successful business, and the children determine that they don't want to live their lives that way. I also suspect that for many of these children, who have enjoyed the financial fruits of their parents' labor, they subconsciously disconnect the labor necessary obtain those benefits. What do I mean? I've seen numerous children of successful entrepeneurs decide to work in lower-paying jobs--becoming teachers, social workers, and other idealistic professions. Some of these, I believe, decide to follow a calling such as this because in the back of their minds they know that they have their parents' financial resources to rely on.
If you're like most of my entrepeneur clients, your children have enjoyed the benefits of you owning the business: but do they want to own the business?
2. Does your family have the ability? Even if your family members do desire to take over the business, ask yourself this brutally honest question: do they have the ability to successfully continue (and even expand) the business you worked hard to create? Anecdotally, again, I've found that in more than half the cases, if a family member actually desires to continue the family business, that family member probably also has the ability. You've ingrained into him or her the work ethic necessary, and your family hopefully will share many of your same values that helped make your business a success. However, your family's ability is not a given. Just because you have a brilliant medical practice does not mean that your child can share that gift you have. Make an honest appraisal of your family members and your business. Does your business require mainly hard work and a certain ethic? If so, your child's desire to continue the business may see him through. Does it also contain certain talents or gifts that most people don't possess? Consider it more closely, then.
3. What do you do when there are multiple family members? I've been writing this article almost as if you only have one child, but the average family, of course, will have two or three children. This could bring multiple complications--all of which can be overcome with planning, but which need to be considered. I've seen all of the following issues:
--A brother and sister both want to run the family business, but don't get along.
--There are three brothers, two already in the family business, but one who is much younger and a minor.
--One child has always been in the business, and the other has never had anything to do with it, and the parent is trying to figure up how to divide his estate fairly between both of them.
None of the issues I have mentioned should keep you from making a succession plan with your family business. To the contrary, they are matters to be considered, and, with good planning from an attorney, an accountant, and perhaps even an investment advisor, they can all be taken into consideration when creating a successful plan regarding your business.
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