All in the family -- and keeping it that way!

Most family owned businesses will at some point be faced with the issue of succession. Who will run the company when the parents die or retire? Should the children be allowed to share in growth and ownership even now?

Certainly many of the more difficult issues will be non-legal in nature. Which of the children is best suited for leadership? How will the valuable employees feel about being bypassed? What about the children who have no interest in the business? What about the children who want to be in the business, but who lack the sense or ability? What is fair?

However, succession raises many important legal concerns as well. Sometimes these concerns can compound the worry and delay the implementation of your succession plan. As the parents' concerns grow and the resulting uncertainty deepens, important decisions are delayed and, indeed, legal concerns are sometimes an all too easy excuse for putting off those hard family decisions that no parent likes to make. Frustration, especially among the children, mounts and family tension escalates.

So what are those legal concerns? Well, they will vary from business to business, but here are some of the more or less universal ones:

* Once you give shares to your children, they own them. They can vote them any way they like, and even if you gave them away for nothing you can't take them back just because you're parent.

* The fact that your shareholders are your children does not make them any less shareholders. Even children have minority shareholder rights. If you have a falling out, these minority shareholders can become a major headache. While in most businesses the family relationship itself will do more to control disputes than any contract, the sobering fact is that this isn't always the case. Children grow and children change, and it is surprising sometimes how stress, family arguments, and maturation (not to mention the influence of spouses, perhaps ones you haven't even met yet) can change people in unexpected ways.

* If your child ever runs into financial difficulty, his or her shares can be auctioned off to outsiders by his or her creditors.

* If your child ever has matrimonial problems, some of those shares could end up in the hands of the disgruntled ex-spouse (and, no, daughters are not immune - men are just as entitled as women to make matrimonial property claims against their spouses).

* If your child passes away, the shares can be willed to anyone he or she likes; even the Cult of the Cosmic Muffin.

* If your children are unable to agree on how to run the company after your death, the resulting squabbling and deadlocks could result in the dissolution of your company, and quite possibly, its financial ruin.

Of course, usually these kinds of problems do not arise. Hopefully, your children will always be sensible, will always get along with you, will never have matrimonial problems, and will never get into financial difficulty. Of course, almost everyone thinks that way and almost no one, related or not, enters into a commercial arrangement fully expecting that there will be problems. So how come litigation lawyers are always so busy? Suffice to say unpleasant things do happen. Suffice to say also that when they do happen, it is almost always unexpected.

The fact is, however, these sorts of legal risks can usually be dealt with.

A number of legal strategies are available, but the most important tool in dealing with these sorts of concerns is the so-called unanimous shareholder agreement. Very simply, a unanimous shareholder agreement is an agreement signed by each and every one of the persons who are shareholders on the date it is signed. There are three legal features of a unanimous shareholders agreement that make it particularly well suited for dealing with these sorts of concerns. First, it is a contract and hence, as in any contract, the promises it contains are legally binding upon whoever signs it (assuming they are adults of full capacity). Second, as a matter of law, it is also binding upon all (even minors) who become shareholders after the agreement is signed; that is, even if they didn't sign anything and whether they expressly agreed to become parties to the agreement or not. Third, a unanimous shareholder agreement allows the shareholders to agree, in advance, on how the powers of the directors and officers will be exercised; this is not possible under an ordinary shareholders agreement. Because of these features, some of the most common sources of succession related concerns can be dealt with:

"I want my children to take the reins, but I want to take those reins back if things don't go well".

Even if you issue voting shares to your children now (and even if you give them a majority of those shares) you can use a unanimous shareholder agreement to retain control over the company and/or retain a veto power over decisions of particular importance. This sort of invisible string lets your children operate the company freely while allowing yourself full opportunity to stick your oar back in if you ever feel it appropriate to do so. Indeed, the mere fact that you possess this power is often a sufficient brake on the directions that your children take the company. You can also retain an option to repurchase the shares, even at a discounted price, if you ever feel the need to do so (although specific tax concerns need to be investigated in each case).

"I want to give my children a minority interest now, but I don't want them (or their spouses or heirs) to give me trouble if we have a falling out".

There are several things you can do in a unanimous shareholder agreement to minimize the impact of minority shareholder rights. For example, you can retain an option to repurchase the shares at any time or upon the occurrence of certain events, possibly at a discounted price. In some cases at least, minority shareholders' rights can be effectively removed. Also, through certain drafting techniques, you can better solidify the understanding that the issuance of minority shares to your children was not to impede your unfettered ability to run things the way you want.

"I built this business for my family and I don't want any part of it going off to exspouses or creditors (or the Cult of the Cosmic Muffin)".

Through various means you can make the acquisition of shares by interloping outsiders difficult, unattractive and at the very least, curable. For example, your agreement can expressly prohibit transfers to persons outside of your family (although it is uncertain just how effective that will be legally) or it can contain rights to buy those shares back under a right of first refusal or an option. You can also try so called poison pills, clauses which strip away rights from or impose obligations upon, outsiders who acquire shares without the consent of the parents.

"I intend to distribute my shares under my will, but as I won't be around I am worried that a dispute will develop then".

A unanimous shareholder agreement will be binding on the inheritors of your shares. Even if you are currently the only shareholder, there is no reason why you cannot sign an agreement now (yes, with yourself) which will govern the relationships between your heirs after death. For example, you can say now who the directors or officers will be or how they will be chosen. The agreement can also contain requirements for supermajorities (i.e. more than just 51%) for certain kinds of business decisions or for guaranteed board representations to all children. It might also contain buy-sell arrangements to facilitate a fair and orderly departure of those who wish, or are compelled, to leave if a dispute does develop.

"I may want to sell my business one day and since I may need to do that through the sale of 100% of the shares I need to hold on to all of them."

A shareholder agreement can be drafted to contain so called "drag along" or "bring along" provisions which, once again, will be binding on your children and any other person who happens to acquire his or her shares. Under such a provision, the children can be compelled to include their shares (usually for a pro rata share of the price) in any offer you accept for the sale of the company's shares.

Not all of these techniques have been tested in the courts and certainly some of them (e.g. the use of poison pills to hinder certain types of debt enforcement procedures) are of more limited use. However, by using the right combination of techniques, the risk can always be reduced and, in most cases, practically removed. Furthermore, (and this is a point that is often missed), even a clause of uncertain enforceability gives you a negotiating lever that you would otherwise would not have had.

Here are few other points to consider in planning your succession arrangements:

The Power Vacuum 

Think about what would happen if you (and/or your spouse) were to suddenly die or become incapacitated. Who would run things? Who would sign the payroll cheques the next day? The resulting lack of effective legal control could cause some very severe problems. You can use a unanimous shareholder agreement to establish a caretaker committee to run things until you or your estate have an opportunity to clear things up.

Appointing Directors

Being a director carries with it a host of potential liabilities. It is one thing to make your children officers; there is generally no harm in doing that. But asking your children to stick their heads above the trenches by making them directors as well isn't necessarily doing them a favour. An Alberta company requires only one director, and in family held companies, it is often wisest to appoint a single director; why expose the entire family to gunfire? Furthermore, through the use of a unanimous shareholder agreement the non directors can still exercise some measure of control without the attendant risk. (Note, however, that if your children are engaged in jobs for which Workers' Compensation Board premiums are payable that they will only be eligible for exemption if they are also made directors.)

Choosing Share Classes and Numbers:

It is common to issue non voting shares to children in the belief that by doing so the children will be precluded from interfering with important decisions. Since the shares are non-voting, often very little consideration is given to the relative number of shares that they hold. The problem is that certain kinds of corporate decisions (most notably amalgamations, changes to the corporate constitution, and the sale of the business) require the approval of persons holding two thirds or more of all shares; i.e. even non voting shareholders. Consequently if you issue enough shares to your children (even if non-voting) you may unintentionally give them effective control over the most important of corporate decisions. Furthermore, if the nature of your child's shares are such that they are affected in a manner differently than the other classes, their class is allowed to vote separately on the same issue. The end result can be that your children are effectively given a veto on fundamental issues. The simple solution is to use care in deciding upon the classes and absolute numbers of shares that you issue to your children. Once again however, through the use of a well drafted unanimous shareholders agreement you can also avoid the problem by requiring your children to vote in the manner you direct.

Now, back to those more difficult non legal issues. As mentioned, the legal issues are usually resolvable, and it will typically be the family type issues that will give you the most grief. Furthermore, while a good lawyer or accountant can be of some use in sharing with you their thoughts and experiences, the fact is that they are largely unqualified to deal with non legal family type issues. On these sorts of questions you may want to seek out people who have had to endure the same process. Most major centres in Canada, including Edmonton and Calgary, have a local chapter of the Canadian Association of Family Enterprises (CAFE). CAFE is a non-profit association of family-owned businesses established specifically for the purpose of providing its members with advice and support on issues of relevance to family-owned businesses, particularly succession.