Estate Planning In North Dakota

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Aligning Risk, Control and Profit

Business ownership is based on the risk assumed by each co-owner. Business ownership allows the owner to share control and earnings of the business. This page considers how to align risk exposure with the rewards of control and profit for accepting risk, especially as each of these vary while the business is being transitioned to new owners.

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In the perfect world, the risk exposure accepted by a business owner aligns with the owner's control and profit.  That is, the sole owner of a business has all the risk exposure but is entitled to all the profit and has sole control of the business.  In a two-person business with each owning 50%, each co-owner is expected to have 50% of the risk exposure, have 50% of the control and receive 50% of the profit.  Or if one owner has 75% of the risk exposure, that owner should be entitled to 75% of the control and 75% of the profit.  The ownership interests do not need to be equal among the co-owners; instead, the expectation is that each owner has an identical portion of risk exposure, control and profit.

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The world is not that simple.  There will be times when the portion of risk does not align with the share of control and profit.  Such a misalignment could be intentional, that is, one co-owner wants to assist another owner by accepting a disproportionately larger share of the risk.  A misalignment among risk, control and profit also can arise inadvertently when something changes in the business that shifts risk but the formal structure (i.e., distribution of control and profit) of the business is not updated to reflect the altered relative risk exposures.

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Both types of misalignment need to considered by co-owners; that is, 1) how much misalignment among risk, control and profit are the co-owners willing to accept in order to achieve their agreed upon goals, 2) how do they monitor the alignment among risk, control and profit in anticipation of changes over time, and 3) how do they realign risk, control and profit when the desired alignment is no longer met.  The answer to question 1 will be determined by the co-owners, but there may be tax and debt financing consequences.  Answers for questions 2 and 3 are perhaps less objective and more methodical. Each question is addressed more fully on this page.

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Limits on Misalignment

Risk, control and profit do not need to be perfectly aligned, but there may be tax consequences as well as concerns from lenders if the misalignment exceeds an acceptable level or tolerance.

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Monitoring Alignment

The relationship among risk, control and profit can change during the normal course of business operations, such as, one co-owner withdrawing a greater portion of earnings as cash while the other co-owner retains more earnings as capital in the business.  What process should the co-owners use to monitor such changes in their business arrangement?

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Re-aligning when Necessary

What process should the co-owners consider realign risk, control and profit when the alignment has changed as a consequence of either normal business operations or an explicit decision to shift the portion of ownership?
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Closing Thoughts

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