Startups and Estate Planning – The Challenging Intersection
Recently I have had the opportunity to meet several people involved with young companies and startups. Having been part of two startups (not counting my own company) I am familiar with some of the issues associated with owning a part of a private, growing company.
Being part of a startup is exciting, fast paced, and adventurous. As the minority owner of private stock, problems can arise which require specialized knowledge and attention. You may find yourself in business with a family member or spouse of a former shareholder via death, divorce, or disability. Generally, this individual knows nothing about the business and wants nothing to do with the business. In such an instance, how does one deal with this issue? A stock buyback program, a shareholders agreement, or something else? In addition, how can anyone place a value on the shares of a private company for some unknown date in the future?
Even if a company has a program to buy the stock of a former shareholder and if there is a solid valuation methodology in place, where does the money come from to buy the stock? Well, these are a lot of ifs. We all know that people get sick and die, but companies do not. Anyone who has put their heart and soul into a company would want to know that they or their family will receive the benefit of their toil.
To address these potentialities, a few things need to be put into place. For example, a stock repurchase plan ensures that the departed shareholder will receive a determined amount of money for his or her shares based on a flexible valuation method that is tied to certain, predefined metrics. Life insurance is purchased on the lives of the key shareholders to A) provide cash to buy back the stock and B) provide cash to acquire new talent. Some refer to this as “key man insurance”. Without such a plan the widowed spouse would become a shareholder with no way to convert that wealth into cash – or worse want to get involved in the daily activities of the enterprise. In the event the deceased shareholder did not leave a properly executed will, the story has the potential to get much worse. Now, not only is the company missing a key person, it may not be clear who their new partner is.
In summary, it is in the best interest of all shareholders to make sure that the stock stays in the company by having all parties execute an agreement to purchase the stock of a disabled, ill, or deceased shareholder. A little planning in this area can prevent all sorts of problems that would serve as a distraction, or even a disaster.