Ed. Note: This is the second installment of a two-part blog exploring an important topic that is too often ignored: business divorce. When family members, friends, or business associates come together to launch a business, rarely do they take time to consider what will happen if things don’t work out. To read Part I, authored by Hugh Carlin, click here.
Very few people have the foresight to plan for the ending of something that is just beginning. Even if they think about it ahead of time, who wants to plan to sell the dream home you are just closing on? Who wants to craft a prenup for the new marriage you are planning to last a lifetime?
The same is true in the business world. When a business venture is launching, there are typically plenty of agreements in place. Ownership stakes are spelled out. Roles are defined. But too often, the infrastructure for when a business ends is not considered. That can lead to serious complications if an ownership relationship splinters.
At Gross Shuman, we work closely with business owners and entrepreneurs both here and in Canada who are launching businesses. If it is a business that involves multiple owners, we recommend and craft agreements that contain clear and precise language for instances where owners disengage or decide to break up the venture. The time invested here in the early stages, gives our clients peace of mind that, should things change in the future (as they often do), there will be no question as to how to proceed.
This type of preplanning is particularly important in the event the business is successful and is not coming to an end, but rather an owner desires to exit, or needs to be forced out for one reason or another. Absent the proper planning, the person headed for the door could be inclined to do some costly damage. A protracted fight can drain resources and jeopardize the survival of the business itself.
This is not to suggest that if you have a clear agreement set out, you won’t end up in court. It can and does still happen. But, if you do find yourself in either litigation or mediation to address a business divorce, having a strong agreement from the outset can streamline the process, protect all parties, and preserve the business.
Some of the common reasons we have heard from clients who think they don’t need a business prenup, if you will, include:
- She is my best friend, we aren’t going to have any issues
- My partners are my brother and my uncle. We’re family.
- This is a small business and it’s just the two of us. We don’t need to complicate it.
- My partner is financing this venture. I don’t want her to think I don’t believe in the business or don’t trust her.
In each case, our attorneys offer a detailed explanation of why it is still important to protect yourself and your business, but for sake of this blog, I’ll boil it down to a simple analogy:
You don’t expect your house to burn down. It’s new, it has fire alarms hard-wired in. It is built to the latest code. You have fire extinguishers in every room. Does that mean you don’t carry insurance? Of course you do, because while we may not anticipate bad things happening, they do happen, and you’ve worked too hard to leave anything up to chance.
We often share examples with our business clients of the most common things that can go awry in a business partnership, and how we can address them preemptively in a partnership agreement.
You don’t want to continue the relationship
Life circumstances change, health issues arise, people evolve, there are many reasons why you might want to end the business relationship. There are countless examples of incredibly costly business divorces born out of this single reason. We work with our clients to create buy/sell language that spells out the exact process for one partner to buy another out. But that is only half of the challenge.
If you are going to buy your partner out, you may be tempted to see the value of the business as lower, and he may see it as artificially higher. Because the value of a business can be, to a degree, subjective, you’ll want to have a provision in place in your partnership agreement as to how the fair market value of the business will be determined. One common tactic is the inclusion of a “shotgun clause.” Simply speaking, it allows one partner to offer to buy out the other at a chosen price. The partner can accept that price, or he can flip the table and offer to buy out the first partner at the same price. Think of it in terms of your kids sharing a candy bar. You allow one child to break the bar, and the other to choose which half they want. It keeps one side from taking more than their fair share.
You and your partner are unable to agree on a big decision
She wants to expand to a second location, and you want to stay focused and grow where you are. He wants to take on a new product line and you see the manufacturing costs as too big of a risk. What do you do when you simply can’t agree? It is an incredibly common occurrence, and it can often be the downfall of the business. But it doesn’t have to be. Your initial agreement can have a provision that covers what to do in the event of, in effect, a tie. What those provisions contain will vary from business to business, but this is an easily avoidable headache.
Your partner isn’t holding up his or her end of the bargain
Two years into your business, suddenly you feel like you are doing a disproportionate amount of the work. Your partner seems to be taking more time away, and overall is less invested in the success of your business. Often times people feel trapped in these situations, but you don’t have to be. Having something called an interest dilution provision in the partnership agreement can offer options to reduce the ownership percentage of the partner who isn’t delivering. While these can help, they are not airtight. Click here to read about a few interesting cases where the courts ruled on both sides for such a provision.
This may all seem overwhelming, but it boils down to a simple fact: like many things in business, time invested on the front end will save you time, money, headaches, and possibly even your business, on the back end. Our corporate attorneys understand that all too well, and that’s why we focus on crafting the strongest partnership agreements on the front end to meet the unique needs of each client.
Trevor M. Torcello is a shareholder of Gross Shuman P.C. who focuses his practice in the areas of commercial real estate, business transactions, agribusiness and working with emerging businesses. He has extensive experience representing various parties in complex business transactions. He can be reached at 716.854.4300 ext. 227 or email@example.com.