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Breaking up the band

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  • SIMA
- Posted: November 6, 2017
By Tom Marks

Everything was going so well. You and your business partner(s) had been getting along for years, growing the company and, hopefully, making money. Then, things started to go south in one of three ways:

1. Your partner decided he wants out. He wants to leave the business and demands a buyout. You either don’t have the money or refuse to meet his demand. You have no contract dealing with this scenario and thus no legal roadmap for how it gets handled. Your partner hires a lawyer; threatens to file an action to legally dissolve the company if he’s not bought out and starts making all sorts of other claims. I call this the “hostile partner” scenario.

2. Your partner is not hostile. He just does not want to work anymore at least not like he used to work. Perhaps he wants to retire or resign. Maybe he has gotten lazy or just has one foot out the door. He has effectively become part time (or no time) and does not pull his weight. He is basically riding your coattails. I call this the “hanging on” scenario.

3. You gave a minority partner equity in the company. Perhaps he was a high-achieving employee and you rewarded him with 20% of the stock. You now want to terminate his employment. Maybe his performance has dipped or his attitude has changed. Regardless, you decide to let him go as an employee despite his holding 20% equity in your business. I call this the “seller’s remorse” scenario (since you probably regret having sold him any stock in the first place).

All three scenarios have one thing in common: Absent a previously signed shareholder’s agreement, the “bad partner” will retain 100% of his ownership rights, even after he is long gone.

These include all rights bestowed by law:
  • Mandatory notice of all shareholder meetings and the right to participate and vote.
  • Access to numerous company records, including pertinent financials.
  • Continued proportional sharing of all profit distributions.
  • The same proportional share of the net proceeds of any business sale, whenever that occurs.
That’s right: Your old “partner” will remain in the mix long after he’s left the building. He will also share proportionally in all future growth of the company, despite no longer doing anything.

Coming to agreement
How can this be avoided? You and your partners should negotiate and sign a comprehensive shareholder’s agreement, often called a “buy-sell” agreement. These agreements specify requirements of continued ownership and how any buyout will be valued and structured. Many business owners use such agreements to address situations like an owner’s death, disability or divorce.

Unfortunately, many of the buy-sell agreements I see do not address the scenarios I outlined. Thus, when the partners stop getting along, or when one stops carrying his weight or is terminated, the business can become paralyzed. The “good partner” is trapped, forced to decide between an expensive (and perhaps financially impossible) buyout; living with a hostile, non-contributing or even terminated co-owner who maintains the same rights; or dissolving the company.

Anticipating terms
A thoughtful buy-sell agreement will address these issues. Partners should anticipate the various circumstances that would trigger a buyout, along with the buyout terms.

These should include a partner’s expected contributions of time and resources to the partnership. If the thresholds are not met, then there would be a mandatory buyout, usually over a period of several years. The period should be long enough so the company can comfortably make payments. Otherwise the buyout could make the business insolvent. The buyout price will obviously depend on the business valuation, a topic that was discussed in the September issue.

I tell all my business owner clients to draft buy-sell agreements while everyone is getting along, preferably when the business is getting started. Once tensions arise, the opportunity to draft a mutually agreeable contract has likely passed. Then the money you’ll spend will dwarf what you would have paid to proactively address these issues. Consult with counsel about how to draft a buy-sell agreement that best fits your company’s ownership structure.

Attorney Tom Marks specializes in business law and estate planning. Contact him at tjm@thomasjmarks.com.
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