As a business advisor and dental attorney working with many dental practices and individual dentists, I commonly field questions from clients and make recommendations to clients regarding their estate and succession plans. Each client that I talk with may have a different motivation for raising the question, or recommendations may vary depending upon the specific facts and circumstances of the client involved. This blog post discusses the impact of a shareholder agreement on a dental practice and an individual dentist’s succession plan.
Why Am I Talking About This?
When we are working with dentists, we always talk about the importance of systems and structure. We talk about minimizing disruption to maximize profit within their business, and the many ways that we can do that. And, one system we can implement is anticipating certain disruption within a business and plan for how to handle it. As an example, what do we do if our business partner abandons the business, dies, files bankruptcy, is convicted of a crime, or gets divorced? We see many closely-held businesses, whether family-owned or nonfamily owned, including our dental practices that operate through informal understandings and handshakes. And, that works just fine right up until the moment that it does not work. Thus, we encourage our business owners to have a shareholder agreement that lays out the operations and the succession plan for these disruptive events. The shareholder agreement documents the mechanics of ownership and the transition of that ownership. It is a really important document when we have more than one owner. The importance of that document cannot be overstated.
What Is a Shareholder Agreement?
It is a legally enforceable document. A shareholder agreement outlines the details of a business entity so that there is no confusion as to the rights of each shareholder from the beginning. While the articles of incorporation will identify the key players in the corporation, the shareholder agreement will clearly outline everyone’s roles and responsibilities. Having a shareholder agreement in place that you have read and understand is another best practice we advise for every closely-held business. This is a system and structure that should be in place each and every time. If you do not have a shareholder agreement, and you have more than one owner, start working on a shareholder agreement as soon as possible.
Nardone Comment: When I refer to a shareholder agreement, I am really referring to any buy-sell agreement whereby the owners have entered into an agreement regarding the transition of ownership interest. This has been traditionally referred to as a shareholder agreement because of the popularity of corporations back in the day. That is, shareholders own shares in a corporation. But, with the prevalence of partnerships and limited liability companies, agreements can also be called partner or member agreements, respectively. Partners own partnership interests in a partnership and members own membership interests in a limited liability company. For ease of reference, we will stick with referring to a buy-sell agreement as a shareholder agreement and the owners involved as shareholders.
What Goes Into a Shareholder Agreement?
The contents of a shareholder agreement depend on the entity and its owners. It usually covers topics, including: (i) shareholder rights and responsibilities; (ii) share ownership and valuation; (iii) management of finances, business, assets, capital, and shares; (iv) rules for issuing new shares and restrictions on share transfers; (v) actions to take upon the death or incapacitation of a shareholder; (vi) conflict of interest rules, such as a non-compete clause or non-solicitation clause; and, in some instances (vii) dispute resolution methods.
Importantly, the shareholder agreement should:
- Clarify ownership decision making authority. That is, who makes what decisions, what the decision rules are when it comes to majority, supermajority, or unanimity, and what ownership percentages constitute the majority. This needs to be specifically spelled out and discussed. And, the benefit of discussing it at the beginning of the relationship is that you begin to establish what the systems and structure of that decision-making process should look like before you have to make that decision. It is all about expectations and understanding between the owners.
- Place restrictions on the transfer of ownership, such as prohibiting non-licensed individuals from being owners. This is the succession plan. What do you want to happen to your ownership? Do you have a daughter that is going to be a dentist? Are you married to a dentist? Does your spouse want to continue to own your interest, and what do the other owner(s) think about that?
- Establish the rules by which shares can be bought or sold, including who has the right of first refusal if someone wants to sell and whether owners have a right to put their shares to the company (e., to sell their shares under specified terms). There is a lot that goes into this, including the ability to pay for that dental practice sale and transition, and the impact on business operations going forward.
- Specify any situations in which ownership must be redeemed, such as when an owner violates the terms of a shareholder agreement or is convicted of a crime. We have to anticipate the unintended events or consequences. We cannot anticipate everything. But, we can certainly rely on history and experience to address most events and circumstances.
- Give minority or majority shareholders certain rights, such as tag-along and drag-along rights, in a sale of the business. What happens if two of the three owners want to sell to a DSO or private equity? Does the other owner that is not selling want to be a business owner and colleague with non-licensed individuals? Or, on the other hand, should we allow one owner to prevent the other owners from selling if we receive an offer that is too good to pass up?
- Determine share evaluation methodology for various situations. This is a big deal in our dental practices, especially with so many differing opinions on methodology. What is the dental practice worth? Do not leave it to chance or some vague principle or appraisal. Address the methodology now.
And, Do I Really Need It?
Without a shareholder agreement in place, your shareholder agreement is whatever the law in your jurisdiction prescribes, which may not be at all what you want. Do not leave one of the most valuable assets that you may have to chance, or some other person’s perspective, and certainly not a court’s perspective. As an example, the last place that you want to be is in a courtroom with a judge that may not understand how a business operates. Most judges that we deal with, although very intelligent and hardworking, are generalists. They are typically overworked and handle many more criminal cases than they do commercial or business matters. And, again, they generally have very little experience with business operations. Thus, if possible, we certainly want to avoid the court process and the interpretation and perspective of our relationship to a court. That is why it is so important to have a very specific and clearly drafted shareholder agreement in plain English.
Also, as part of drafting our systems and structure and having clear communications with all owners, the shareholder agreement drafting and negotiation forces that discussion and brings out those issues early on in the process. It is always best to discuss issues before they arise. By having those discussions now, we avoid the potential stress, complications, and disagreement later. Further, by doing so, it indirectly assists us in improving overall business operations on a day-to-day, week-to-week, and month-to-month basis. It is a good thing.
In sum, we recommend that our dental practices and our dentists consider the importance of drafting and negotiating a shareholder agreement now, not later. Do you think that disruption will never occur? Do you think that no one retires, no one dies, no one gets divorced, no one files bankruptcy, no disagreements ever occur, and no one makes poor decisions that may cause them to find themselves on the wrong side of the law? Well, it happens. So, the shareholder agreement allows us to minimize disruption within the practice and maximize profit for the practice, as well as the individual owners, by planning for those events.
Please see my prior blogs on shareholder agreements, including:
- Understanding the Importance of Having a Buy-Sell Agreement between Partners in a Dental Practice
- Buy-Sell Agreements: Alleviating the Financial Burden Caused by a Required Buy-Out or Redemption of a Partner’s Ownership Interest
- Buy-Sell Agreements: Narrowly Defining a For-Cause Termination Under an Owning Dentist’s Employment Agreement
- Laying the Legal Foundation for a Successful Dental Practice Partnership