In recent years, the headlines have tracked the news of high-profile breakups among business partners in private companies. These business partner fallouts include:

• 2023: Sam Altman was ousted as Open AI CEO (for less than three days) before he was brought back in a dramatic return to the company where he remains today.
• 2022, Republic First Bank CEO Vernon Hill resigned after a power struggle with insiders that lasted for months, including with the bank’s founder, Harry Madonna.
• Also in 2022, real estate developer Steve Ross, chairman of New York-based Related Companies, ended his longtime business relationship with partner Jorge Perez, chairman of Miami-based Related Group, which they said publicly was amicable.
• Finally, in 2020, Forbes reported: “Perhaps no duo on Wall Street has ever soared higher and broken apart quicker than the partnership between billionaires Robert F. Smith and Brian N. Sheth, the co-founders of Vista Equity Partners.” 

Reflecting on these business partner breakups made me think of Leslie Gore’s golden oldie, which still remains popular today: “It’s my party and I’ll cry if I want to.” These high-profile splits among business partners create notable headlines, but with some planning they may be avoidable. Even when a business divorce does become necessary, it doesn’t have to result in tears and trauma for the partners or for their businesses. In this new post, we review steps for business partners to consider that can help avoid conflicts, but which will also provide a more peaceful path to an exit if one of the partners ultimately decides to leave the business.

Document Essential Terms in Writing

The venerable Western saying is good fences make good neighbors. In business, good agreements make for good partnerships. To avoid/lessen conflicts, business partners need to put their agreements in place on key terms that address who controls the business and its operational structure. These terms include: (1) who decides key issues such as compensation, (2) whether to issue executive bonuses and distributions/dividends to owners and in what amounts, (3) whether major company decisions should be made by a bare majority of owners, by unanimous consent of all owners, or by a super majority percentage, (4) if the decision-making structure can lead to a deadlock between the partners on key decisions, what mechanism exists to permit the partners to break the deadlock (a third party will likely need to be involved), and (5) whether to appoint and give authority to independent board members or managers who can provide objective input to the partners (co-owners) about significant issues. 

No business operates without facing challenges, some quite serious. For business partner owners to surmount these challenges, they will be helped greatly if they have created a decision-making structure that includes third parties who provide input and recommendations based on their own track record and experience. Further, partners who look ahead and seek to reach agreement on management and control issues in the business before conflicts arise can avoid more serious disagreements.

Negotiate and Adopt a Business Prenup

There are many anecdotal stories about business partners who worked their entire adult lives together after starting up a private company before they finally sold it or passed it along to their children. Those are heart-warming histories, but they are the exception, not the rule. In most cases, business partners do not stay together for decades; instead, partners will come and go and transitions are not unusual. For this practical reason, business partners should consider entering into corporate prenups with each other when the company is first formed or when a new business partner makes an investment into an existing business. This is an opportune time to enter into this type of agreement governing the exit of a partner as they are focused on the future success of the company and generally have a positive view of each other.

There should be a mutual interest by both company owners and investors to enter into this corporate prenup, which is generally set forth in some form of a buy-sell agreement (BSA). For majority owners, the benefit of securing a BSA is that it provides the owner with the authority to redeem the ownership interest of a minority partner even if that partner doesn’t want to leave the business. No private company majority owner wants to be stuck in business with a minority partner who is dysfunctional, disruptive or, worse, directly interfering with the operation of the business. The BSA therefore provides the majority owner with a “call right,” which permits the owner to secure an involuntary exit of the minority investor if the need arises. 

For minority investors, the BSA will also provide them with a critically important benefit. Specifically, the BSA provides the minority partner with a guaranteed way to monetize his or her ownership interest in the business. In the absence of a BSA, the minority investor will not have the right to exercise a “put right” to obtain a redemption, and the investor may therefore be stuck for years holding an illiquid, unmarketable ownership interest in the company.

Negotiate a BSA That Meets the Needs of All Partners

The BSA will address all of the following issues: (1) when can it be triggered by the majority owner or investor, (2) how will the value be determined of the minority ownership interest that is being redeemed, (3) how will the payment be structured to the investor for the interest that is held in the business, and (4) what dispute resolution procedure will govern the enforcement and application of the BSA between the partners.

These issues need to be addressed right at the outset of the investment, and they need to be carefully evaluated to meet the business objectives of both parties. For example, the parties may decide that the BSA cannot be triggered for some period of years after the investment is made. This is referred to as a “delayed trigger,” which will allow time for the company to grow in value after the investment has been made before it can be redeemed or sold. Both the majority owner and the minority investor may therefore be required to wait three, four or even five years before either side can pull the trigger to either redeem the interest held by the investor or to secure a buyout of the investor’s interest in the business. 

Given that the majority owner also has a redemption right, the investor will want to be sure the majority owner’s right to redeem (purchase) the interest held by the investor in the business is subject to a “lookback” provision. This term protects the investor in the event that the business is sold not long after the investor’s interest is purchased by the majority owner (lookback provisions often last for at least one full year after the redemption of the investor takes place). If the business is sold during the lookback period for a higher value than the investor received in the redemption, this provision will require the majority owner to issue a true-up payment to the investor to ensure that the investor receives the benefit of the higher valuation that was achieved when the business was sold.

Conclusion

Business partner breakups will continue to make headlines, especially when they involve high-profile figures at large companies. But business partners who engage in advance planning and take steps to address internal governance issues can avoid the conflicts that lead to a business divorce. This type of advance planning, including the adoption of a well-crafted BSA, will also lessen the heartaches and headaches if a business divorce becomes inevitable.

Listen to this post