As a dedicated business succession planner, I am often bringing up the subject of employment contracts. The predictable initial response is “I hate contracts and what role could an employment contract have in my business succession planning?” This question generally comes from someone who has 80% of his/her net worth tied up directly or indirectly in their business and does not have a prayer of retiring without concerns about their financial security. They are plagued with the concerns of “Where am I going to get income?” and “How will I replace my current benefit package?” Fortunately, the employment contract can be a very valuable tool in relieving these concerns and facilitating business succession planning.
Most business owners believe that employment contracts are only used for hot shot executives and that if one is created for them, the contract will set them up for a big law suit. To the contrary, an employment contract for the business owner or an executive constructed by a qualified business attorney will significantly reduce the probability for law suits. The fundamental reason being that the contract explicitly confirms expectations and precludes assumptions due to ineffective communication, which when they act together as a dynamic duo, are the primary cause of most lawsuits. Although there is little chance that a business owner will sue his own business, the contract can provide documentation for access to a reasonable income and benefits after retirement when the IRS would otherwise be screaming unreasonable compensation, constructive dividend, double taxation, etc. Through a legally binding contract with the business, i.e. an employment contract, an attorney can develop a contract that provides reasonable benefits and reasonable justification or consideration for those benefits through documentation of their past service and extraordinary commitment to the business reflected in the business’ retention of earnings and profits for working capital, facilities, equipment and growth. The contract would state simply that in light of this documented consideration, the business owner (and/or their widow) will continue to receive salary and benefits after retirement. In effect, the owner becomes a creditor to the corporation with a contractually documented expectation of benefits that are deemed reasonable by the attorney based upon his experience and research into a long history of court cases that substantiated the reasonable continuation of compensation and benefits.
The development and adoption of an employment contract for a business owner can be an integral step in succession planning that facilitates the achievement of a business owner’s succession goals by providing a reliable alternative income source. Furthermore, in recognition of the sacrifices made by most business owners, these contractual obligations, specifically the owner’s salary continuation and benefits, would be a normal and customary business expense and have precedent over the distribution of earnings to the recipient of the owner’s stock, his/her successors. This alternate source of cash flow and benefits should facilitate an exit strategy and the transfer of stock to family members to achieve estate planning or tax avoidance goals.
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