Avoiding Death and Deadlock: Proper Planning For Owner Exits Can Save the Business
The end of a business relationship is no less painful or emotional than the end of a social relationship. Many entrepreneurs in the glow of start-up do not anticipate their management may become dysfunctional or the founders’ visions will diverge. A business can be destroyed by failing to consider an exit plan at formation. Good early planning, however, can provide an orderly exit when the relationship falls apart.
The most common events to trigger the buyout of a shareholder, member or partner in a business are: death, disability, deadlock/expulsion/minority shareholder oppression, voluntary withdrawal (retirement or wanting to pursue other options), termination of employment, bankruptcy/insolvency, family disputes and divorce where the spouse will not relinquish rights to the company.
Many business owners anticipate death or disability of their partners, but what happens if your business partner inherits millions of dollars and loses urgency for working? What if your business partner has to move to California for his wife’s dream job? What if one of you wants to open multiple locations of your retail store, but the other one is content to grow the first location?
These situations often result in deadlock: a point at which two sides cannot agree and a resolution/decision cannot be reached. Deadlock or impasse can destroy a small business.
Formation documents (such as Shareholder Agreements, Buy-Sell Agreements, Operating Agreements or Partnership Agreements) should include requirements for the company to buy back the ownership interest upon these triggering events. It should also specify how the price will be determined.
Good planning should include provisions that could make deadlock harder to achieve, such as electing an odd number of directors/managers, or appointing outside/independent directors who have tie-breaking powers.
There can be mechanisms where an owner can force a buy-out if he or she is no longer happy in the business. These are known as Russian Roulette, Texas Shoot-out, or Dutch Auction.
Where there has been no advance planning, there is often little that can be done to force out an owner or to accommodate an owner who wants or needs to leave the business and get his money out. Some states have judicial dissolution statutes that can force a business to be dissolved upon certain (very limited) events, and there are generally some protections for minority shareholders who are being “oppressed” by the majority in an attempt to force them out (cutting salary or benefits, blocking them from management participation, terminating employment, refusing to declare dividends). These are messy, costly options that make it hard for the business to survive the ousting of an owner.
There is no substitute for proper planning at formation.