“It’s just not working out anymore.” You may have heard or uttered these words as a marital partner, but as a business one? It can happen. Business divorce among privately-held companies is common, and can be just as emotional as one involving spouses. Organizations experience “life events” too, and smart business owners know to prepare for them ahead of time. In his article “The Business Divorce,” California attorney Michael Gold outlines seven key provisions that should be included in every business agreement from the start. Much like a prenuptial agreement, these discussions can be uncomfortable. A thorough agreement developed with a knowledgeable attorney, however, can save future headaches and heartaches for all parties. Does your business agreement include the following provisions?
Provision #1: Responsibilities and Deadlock Breaking
It is important to establish partner responsibilities upfront. This section should also include agreed-upon values, purpose, and vision each partner will adhere to moving forward as the business develops. In the Forbes article, “How I Survived My Business Divorce,” Kathy Steele discusses how not having a values alignment with her business partner led to nasty arbitration. Another critical component of this provision is a deadlock-breaking mechanism. A deadlock provision will resolve a situation where there is a majority disagreement between partners, but no side has the majority vote.
Provision #2: Estate Planning
What happens when a partner passes away? Most business agreements account for the transfer of the business interest to a trustee, but stop there. According to Gold, “The company is then left with a shareholder or partner who is a mere stakeholder and plays no productive role in the company.” Be sure the obligations for heirs or trustees who absorb the interest of the previous partner are clearly outlined.
Provision #3: Buyout Triggers
While death or disability of a partner are the most obvious causes for transfer of interest, other triggers can be overlooked. A partner involved in any of the following scenarios may directly impact the business:
Many companies choose to omit performance as a buyout trigger when crafting an agreement. Unfortunately, this can sometimes lead to a situation where a fired, under-performing partner remains a stakeholder in the company.
Provision #4: Valuation and Payment
According to attorney Jay R. McDaniel, in most business divorces, one side of the dispute will eventually purchase the interests of the other side of the dispute. Therefore, valuation must be included in every business plan. In most cases, fair value is determined early on but rarely updated. Gold adds that all funding other than cash flow needs to be considered, and this provision should include payment terms that adjust for the company’s financial condition.
Provision #5: Post-buyout Competition Restriction
The conclusion of a business divorce can be far from a clean break. It is easy to overlook the protection needed once a partner is expelled. He or she can turn around and start a competing business or go work for a competitor. The partners should agree at the outset that every buyout will include covenants of confidentiality, non-competition and non-disparagement.
Provision #6: Dispute Resolution
Include methods of solving disagreements that don’t require litigation as the only option. Look to alternative dispute resolution (such as mediation) which often times saves individuals thousands of dollars over traditional litigation. As I have written in the past, the courts too often take too much time and cost too much. Instead, include provisions that first require mediation and then arbitration. Put these provisions in your organizational documents. In “How to Execute a Business ‘Divorce’ Without Hard Feelings,” author Malini Bhatia also encourages turning to outside professional entities, such as consultants or advisory boards, to provide objective insight. Together with your partner(s), think about specific scenarios and consult with your attorney on the best remedy for each.
Provision #7: Spousal Consents
Personal and professional lives sometimes collide in the face of marital divorce. How? According to Gold, “[the business] partner’s spouse can claim that the [business] agreement is unfair or in breach of the partner’s fiduciary duty to his spouse.” Obtain written consent to the business agreement terms from all stakeholder spouses. Failing to do so may cause undue scrutiny from a family court.
No one enjoys thoughts of terminating a business partnership when it may still be in its infancy. Planning for a successful future means anticipating all scenarios, even the unpleasant ones. Taking the time to review your business plan together with your partners and a qualified attorney isn’t just good business, it’s a match made in heaven.
Todd V. McMurtry is a Member at Hemmer DeFrank Wessels, PLLC. He is a commercial trial attorney and Harvard-trained mediator. Todd has been married to his wife, Maria C. Garriga, for 31 years. They have three adult children. You may reach him at [email protected] or (859) 578-3855.