Navigating The Business Partner Breakup
Many who read this article are running businesses which are sole proprietorships. Many started out that way, but have grown to the point of needing to bring a partner on board. Others begin their business in some form of partnership arrangement. There are many advantages to partnerships over sole proprietorships. But there are also many draw backs that need to be addressed before a business gets too far along in their development. The fact is, partnerships which at one time help a business to thrive become stale after awhile. Relationships are strained, long term goals begin to conflict, and the overall direction of the business reaches a stand still because the patners are no longer on the same page. When that happens, the partnership needs to be dissolved in a manner that is beneficial to all parties involved.
In a February 20, 2008 report in the New York Times, Deborah Jacobs writes an excellent article which details the potential conflicts which arise in partnerships as well as some helpful tips on how to navigate through them. Here are some excerpts from what she suggests-
Such tangles and many others can be avoided with a buy-sell agreement — basically a business prenup or a postnup, depending on when owners draw it up. In a buy-sell, partners (the process is the same for corporations and limited liability companies) decide what will happen to their interest in the company if events like death, divorce and personal bankruptcy occur.
A buy-sell can prevent an assortment of evils, like becoming unwilling partners with an owner’s heirs, or leaving a surviving spouse illiquid because the remaining owners refuse to buy the survivor’s inherited shares. By requiring a sale under certain circumstances, known as trigger events, and specifying the terms beforehand, the buy-sell avoids conflict and protects everyone, said Louis A. Mezzullo, author of “An Estate Planner’s Guide to Buy-Sell Agreements for the Closely Held Business.”
The best time to arrange the details, which can require 20 pages or more, is before you begin a venture, said Robert E. Gregg, a lawyer with Squire, Sanders & Dempsey in Tysons Corner, Va. Still, Mr. Gregg, who has worked with many start-ups, said there was generally no harm in waiting six months or so until you’re sure the business is workable. Either way, there are issues to sort out.
What events should you include? While some, like leaving the company, starting a competing business or offering shares to an outsider may seem obvious, others could require considerable soul-searching. For example, if a founding partner retires, the remaining owners may feel torn between a desire to reward past work and not wanting that person to get a free ride while they keep pouring themselves into the company.
Who can — or must — buy the business interest when one party wants out? In what’s called a cross-purchase agreement, the option or obligation belongs to the remaining owners. Alternatively, you can use a redemption agreement, which designates the company as the buyer. A hybrid approach typically gives an owner the right of first refusal, with the company next in line if the owner doesn’t exercise it.
When owners’ interests are divided unequally — say, one is a majority shareholder — you may also want to incorporate what’s known as a tag-along provision. Then, if a 90 percent owner sells to Microsoft, for example, the deal must include the 10 percent shareholder too.
The co-founders of the Brooklyn Brewery, also in Williamsburg, relied on their cross-purchase agreement when one of them, Tom Potter, 52, sold 50 percent of the voting stock in 2003 for an undisclosed sum and went to work for a nonprofit. Steve Hindy, 59, the other owner, who held the remaining voting stock, had the option to buy out Mr. Potter. But he chose not to do so because he approved of the buyer: David Ottaway, a longtime friend and one of the first investors in the company when it started in 1988.
How can you value the interests being sold? There are many ways to approach this. If you name a set amount, you’ll need to update it annually to reflect changes in the company, the industry or the economy, said Samuel A. Donaldson, a professor at the University of Washington School of Law in Seattle. A more practical solution is to describe a process for determining the value, whether it is according to a formula or through an appraisal of the company’s fair market value.
It is also possible to vary the purchase price depending on the triggering event, said Charles A. Redd, a lawyer with Sonnenschein Nath & Rosenthal in St. Louis. For instance, you might make it just a fraction of the fair market value when an owner defects to another company, but 100 percent of that value when an owner dies.
What are the payment terms and financing? A lump-sum payout is often associated with life insurance that is used to finance a buyout when an owner dies, Mr. Redd said. You’ll need fewer policies if the company buys a policy for every owner, rather than if they insure one another individually, he said. The alternative is an installment sale, with payments plus interest over a defined period. These arrangements are common in buyouts where the owners don’t anticipate a ready source of cash, which could happen if one owner gets divorced or wants to quit the business, Professor Donaldson said. The legal bill to prepare a buy-sell agreement can cost $2,500 to $15,000, depending on complexity. If your budget is tight, you can rely on the free buy-sell agreement that many life insurance companies offer policy buyers, but it will probably cover only an owner’s death, not other trigger events.
You may be able to save by using a self-help book like “Business Buyout Agreements: A Step-by-Step Guide for Co-Owners,” by Bethany Laurence and Anthony Mancuso, and asking your lawyer to review your draft.
Whatever the price tag, a buy-sell agreement affords peace of mind that some people think money can’t buy. As Mr. Potter, formerly of Brooklyn Brewery, put it in an e-mail message: “Having the ultimate dispute resolution available in case of irreconcilable differences not only keeps you from coming to blows, but makes it less likely that you feel the need to split up in the first place.”
Subscribe to my RSS feed! Thanks for visiting!
