But situational errors affecting business value and succession are not limited to the onset of an illness. In the next point, let’s consider the vulnerabilities that exist with verbal agreements in business.
Full details of the options for a solution could have been arranged are contained in Part 5 of this book.
Error #2: Verbal Agreements in Business Can Lead to Failure
When people make verbal agreements between parties involving a business, it’s usually because they share a relationship of trust. Verbal agreements seem quite normal between members of the extended family, with friends, or with partners, because there is the belief that their involved relationship will ensure the agreement made will be honoured in the manner intended.
However, the problem with verbal agreements used in business is that circumstances can change; people’s recollections become distorted over time and misunderstandings can result not only in relationship breakdown, but also in business breakdown.
When business succession is arranged around a verbal agreement, the results can be devastating, as you will see in the next case.
CASE STUDY # 9 Verbal agreements in a family leaving the successors vulnerable
Sonya retired and handed over her farm business in equal shares to her two children, who had always worked hard on the property.
Sonya took no consideration for the business, but the children verbally agreed to lease the farmland to provide Sonya with the income she needed to fund her retirement. Being a family, they only had a verbal agreement in place, which left the new business owners, Sonya’s children, vulnerable.
When Sonya suffered a heart attack, she decided to liquidate the asset by selling the farmland. Sonya felt entitled to this because she owned it. Unfortunately the children could not afford to buy the land. The new purchasers had other plans for the land that did not include allowing the farm to continue with a lease arrangement. This resulted in the children losing everything they had worked for; they were effectively out of business and a job.
This is a good example of why verbal agreements are not suitable, even in loving or close families. One straightforward technique to avoid this situation would have been to arrange a written formalised lease agreement between the parties so the rights of all involved would be protected. The agreement could have been extended to allow the adult children first right to buy upon Sonya’s decision to dispose of the property. Furthermore, funding could have been arranged with terms to arrange payment over time, or by using insurance to provide immediate funding upon certain events—such as heart attack. For full outline of the strategies, refer to Part 5.
Error #3: Poorly Communicated Succession Plans Cause Dispute and Business Failure
A common error of judgement by business owners is that they attempt to shoulder the decision-making process of succession all alone. Dividing a business in a family situation can be one of the hardest decisions of all, particularly if the main asset you hold is your business and you have one or more competing children hoping to eventually take control.
As the business owner, it is more than likely your right to ultimately distribute and hand over the business in a way that you feel is most appropriate.
However, if an amicable outcome with business continuity and maintained relationships are important to you, a wise strategy is to involve and communicate your intentions to gain feedback and acceptance from the main involved stakeholders. When you fail to communicate with all involved, the outcome could be a disaster for the business, resulting in financial disappointment and relationship breakdown for all the interested parties.
Let’s now consider case # 10 of the business owner.
CASE STUDY # 10
Effects of family disputes after succession leading to dissolution without a sale
In this family business situation the owner, Stuart, was a father with three children. His eldest child, Tim, had worked in the business all his life and had contributed significantly to building the business value. When Stuart died, leaving an equal share of the business to all three children, Tim felt short changed because he had made this business his life’s work.
The business had insufficient borrowing capacity and Tim could not afford to buy out his other siblings when they insisted on liquidating the asset, thereby forcing the sale of the business. Tim contested the will, insisting he deserved more than one-third.
Unfortunately, the business sat closed and abandoned as a lengthy and costly lawsuit ensued over two years. The result was irreconcilable family breakdown and decline in the business value due to loss of income and clientele.
To add insult to injury, an opportunistic competitor established a similar business across the road, effectively gaining all of the business clientele.
This situation could have been saved and all parties’ interests could have been protected if only Stuart had chosen to communicate with Tim about his desire to leave the business in equal shares to him and his siblings.
Tim could have expressed his love and desire to one day own the business, which would have provided the opportunity for them to seek advice about how to structure it so that Tim could take over without his siblings missing out on their share of the inheritance.
There is an easy solution to this problem, which would involve Tim entering an agreement with his father to buy out the business upon certain succession triggers. The agreement could be arranged to provide Tim with full funding by using insurance and vendor finance terms to facilitate the transaction. Full details of the solution strategy options described here are covered in Part 5.
Making known a business owner’s succession intentions when they leave is only part of the communication required within a business to ensure every stakeholder understands their rights and responsibilities. Communicating the exit terms from the start of a business relationship is essential for a fair outcome during times of internal disputes, as you’ll find outlined in the next situational error.
Are Verbal Agreements in Business Succession Plans a Good Idea?
In business situations, verbal agreements about succession plans, or indeed any aspect of the business, are usually made because the people involved share a relationship of trust. Operating on verbal agreements appears to be quite acceptable among members of the extended family, with friends, or with partners, because there is the belief that the quality of the relationships will ensure that agreements will be honoured in the manner intended.
What happens to the verbal succession plan when things change?
However, the problem with verbal agreements in business is that circumstances can change – people’s recollections become distorted over time, and the resulting misunderstandings can cause not only relationship breakdown, but also breakdown of your business.
Case study – verbal agreements in a family succession plan leave the successors vulnerable
Sonya retired and handed over her farm business in equal shares to her two children, who had always worked hard on the property.
Sonya asked for no payment for the business, and the children agreed to pay a lease fee for use of the farmland to provide Sonya with the income she needed to fund her retirement. They did not have a formalised lease and arranged the terms on a verbal agreement basis , which seemed fair to everyone at the time because of their family relationship.
When Sonya suffered a heart attack, she decided to liquidate her assets by selling the farmland. She felt entitled to do this because it was her property.
Verbal Agreements Can Lead to Relationship and Business Breakdown…
Unfortunately Sonya’s adult children could not afford to buy the land and the new owners plans for the land did not include allowing Sonya’s children to continue farming under a lease arrangement. This resulted in the children losing everything they had worked for – they were effectively out of business and even out of a job.
This sorry story is an excellent example of why verbal agreements are not suitable succession arrangements, even in loving or close families.
How to protect all members of your family in your succession plan
One straightforward succession solution to avoid this disaster would have been to arrange a written, formalised lease agreement between the family members so that the rights of all involved would be protected. The agreement could have been extended to allow the adult children first right to buy upon Sonya’s decision to dispose of the property.
Furthermore, funding could have been arranged with terms to arrange payment over time, or by using insurance to provide immediate funding upon certain events—such as a heart attack.
Discover more succession solutions
You can read the full details of suitable succession strategies for similar situations in Part 5 of my book “Your Business Succession: How To Exit Your Business With Maximum Cash Flow and Profits.”
To Your Profitable Business Exit,
Leigh Riley
Succession Solutions Specialist
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