Many start-ups have co-founders. The idea is that the co-founder can help with the daily tasks and add needed skills to the team. Co-founders can also help keep each other accountable. They can also create complexities. One such complexity happens when a co-founder dies.
Those of you who know my story, know that I experienced this personally. It changed my life and was something that I was not prepared for and my co-founder’s family wasn’t either. I ended up working with the Austin probate attorneys at Kreig LLC to find a fair solution for all parties and wanted to share a few thoughts on how start-ups can help plan for the death of a co-founder.
Buy-Sell Terms & Agreements in Texas
Like it or not, if your business partner dies, you and your business will have to deal with it.
The starting point is to consider the terms of your business agreements. The agreement will vary depending on how the business is structured.
LLCs and partnerships will generally have buy-sell provisions included in the formation documents. This language is often baked into standard formation documents with little to no thought put into them. We’ll come back to these below since LLCs and partnerships are the default entities when the start-up does not form a corporation.
C corporations will usually have a stand-alone buy-sell document–assuming that the parties took the time to prepare one. Since these documents are not in the formation documents and one has to go somewhat out of their way to prepare them, they are usually custom and negotiated in advance. So we’ll skip these agreements for the purposes of this post.
The Standard Texas Buy-Sell Terms
The standard buy-sell language in Texas LLC and partnership agreements will usually be found in the dissolution section. The agreement may or may not include the death of a co-owner as a dissolution event.
If the term does include death as a triggering event, the language will often go on to say that the surviving owner is to buy out the deceased owner. It may even say how the price is to be determined and when the payments are to be made.
For example, the language may say that the price is book value, the current capital account balance, or even the current fair market value. The payment terms may provide for payment by a company-owned life insurance policy, a promissory note with payments over time, or some other arrangement.
You can see from these terms that, preferably, these are all things that should be negotiated when the parties start the business. Suffice it to say that this often does not happen, as was the case with my start-up. In fact, I’ll admit it, my start-up was like many others. It didn’t have any documents. Our focus was on getting the business going, and legal compliance was put on the back burner.
When There is No Buy-Sell Agreement or Terms
In the absence of buy-sell agreements or terms, Texas probate law is going to say what happens to the deceased owner’s interest. This in turn depends on whether the founder has a valid will (which in my case, he did not), and if there is no will, then Texas intestacy law.
Texas intestacy law is a set of rules that says who gets what when there is no will. These rules in turn on whether the owner was married, had kids, and whether the business was community property or separate property.
With each option, chances are good that the business will be stuck in the probate process for most of a year or longer. This means that those inheriting the business interest have a right to the profits and, eventually, to ownership of the interest or payment for their interest. This can be fatal for the start-up. It can result in a distraction and deplete funds that need to be focused on growing and sustaining the business.
Recommendation
I learned these lessons the hard way. Having been there, my recommendation is to consider your co-founder’s family relationships at the start. It is also to assume that you will have to deal with the surviving family members when they are at their worst. Given this assumption, what terms do you need to include in your agreement to keep the business going and to have a fair payout or another arrangement for the surviving family members? It can take very little time to incorporate these terms into the formation documents, particularly if life insurance and other more complex terms are not included. So even if you do not get your estate plan in place, you should have these documents in place.