/>iDuring Valentine’s Day month, we are taking a look at 50-50 owned private businesses. Forming a co-owned company may sound like a good idea on paper because the two partners are close friends or family members who are making the same investment, sharing equal control, and receiving the same financial returns. But, as in marriages, the co-owners may run into conflicts they cannot resolve, which could require a costly business divorce. This is the chief problem with these co-owned businesses: When conflicts arise the partners cannot work out, they will be in a position of deadlock that distracts or ultimately derails their business.
The Deadlock Dilemma Is the Real Deal
The risk of a co-owned business capsizing over unresolved conflicts between the owners is substantial and many of these companies come apart because the partners failed to create any type of dispute resolution process. Here are two examples: first, the ubiquitous Buffalo, New York, law firm of Cellino & Barnes, broke up in 2020 after 25 years, but only after the partners engaged in a highly publicized, three-year-long legal battle resulting in a court-ordered buyout. The litigation between the two law partners was so contentious it led to an off-Broadway play produced about the case. The second example is the lengthy legal battle between the co-CEOs of TransPerfect Global, Inc., the translation services company, which the parties finally settled in 2020 after six years of litigation.
In light of the high risk of conflicts arising in the future between the co-owners of these businesses, the two partners should consider whether this ownership structure is truly their best option. If they do decide to go down this road, however, the good news is that they have some options to consider. This post reviews specific, practical steps the co-owners can take to head off problems that might otherwise cause their partnership to end in a bitter feud.
Another Approach: Shared Financial Returns, But Not Equal Co-Ownership
One approach for the partners to consider that will avoid future conflicts is to adopt an ownership structure that provides financial equality, but with a modified ownership percentage. Under this approach, the partners would agree to an ownership percentage of 51% to 49%, but also agree in the company’s governing documents to share equally in the company’s profits and losses, as well as in the amount of their compensation. This structure provides for both partners to share the same financial results from the company’s performance, but it establishes a process for decision-making by the company that will not result in gridlock.
Further, the majority owner will have the right to make operating decisions on a day-to-day basis for business, but the minority partner will also have veto rights over some of the most important decisions, and these will be subject to negotiation. By way of example, the partners may decide that a unanimous vote of both of the partners will be required to admit new partners, to approve the sale of the business, and/or to permit the company to take on debt above a certain amount. This structure thus avoids conflicts over most of the decisions that need to be made to keep the business moving forward.
Create a Set of Clear Tie Breakers
For partners who are insistent on having equal ownership in the company, it is critical for them to adopt a tie-breaking mechanism that will prevent them from reaching the point of deadlock over future business decisions. Some of the tie-breaking options available to the partners are reviewed below.
- Zones of Authority
For certain companies, the roles of the two partners will be distinct, and in those businesses, the partners may be able to agree that each partner will have the authority to make decisions in their own domain. For example, a partner in charge of marketing and business development may be given authority to decide on what the website will look like, who to hire/fire in the marketing/sales department, and what marketing strategy to adopt. Similarly, a partner running the company’s back office may have the authority to select the accounting software and the CPA firm the company uses, to set pricing on products or services, and to hire a CFO or comptroller.
The problem with this approach is that the partners will have to agree on some decisions that do not fall into these clear categories and they may have conflicts deciding other issues, such as the amount of the company’s expenses, profits distributions, acceptable debt level and growth rate. The bottom line here is that there will still be many common areas in which a potential deadlock may arise between the partners.
- Create a Neutral, Tie-Breaking Authority
The obvious tiebreaker is for the partners to agree to appoint either one person or a small committee or board (usually three people) who have some industry or other experience and who will make decisions to resolve all conflicts between the partners. While this approach sounds reasonable, it may be difficult for the partners to agree on the selection of one person or of a board of three people to serve in this capacity for the company.
In addition, even if the partners can agree on the specific person or people they wish to appoint, these individuals may not be willing to take on this role knowing that, at some future point, they will disappoint one of the partners by making a final decision that rejects the other partner’s position. To persuade anyone to serve in the capacity of a tiebreaker, the partners will also, at a minimum, have to agree to fully indemnify the people who agree to serve in this role. The partners will also have to agree to pay the legal fees for any and all disputes incurred by the tiebreakers in which they become involved because they agreed to serve in this role.
- Adopt an Arbitration Procedure
For more complex disputes, the partners could agree to arbitrate these conflicts on a fast-track basis that resolves the dispute in 60-90 days. This is a much more formal approach to conflict resolution as it would involve using a private arbitration service, but the process will result in a clear, final and non-appealable result.
Further, before the parties agree to participate in arbitration, they could require that a mandatory, in-person mediation be held before any arbitration is filed. This would requires the parties to engage in one last mediated settlement conference in efforts to reach a resolution before they start any sort of legal process.
Enter Into a Negotiated Buy-Sell Agreement
Even when the partners do appoint an individual or board to resolve any conflicts that arise between them in the future, that may not end their discord. The partner whose position was rejected by the individual or board may be frustrated by the outcome, have hard feelings toward the other partner, and/or be concerned the company is now going off track. In this situation, the partners need to have a buy-sell agreement in place that provides a clear process for the exit of a partner to take place. If there is no off ramp for a disgruntled partner, things may go downhill rapidly in the business, because this unhappy partner may decide to create disruption (or worse) in the business in order to pressure the other partner to buy out that partner’s interest. These types of legal disputes between co-owners involving claims for breach of fiduciary duties can create significant distractions and substantial expense for the partners and the business.
The buy-sell agreement between the partners needs to address all of the following issues: (1) what are the circumstances under which the buy-out can be triggered (who can trigger it and how is it triggered); (2) what is the process for determining the value that will be paid for the departing partner’s ownership interest in the business at the time of exit; (3) what specific terms apply to the buyout payment (how many years, what interest rate and what collateral will be provided in the event of a default); and (4) what is the dispute resolution process for resolving any conflicts that arise regarding the application of the buy-sell agreement.
A critical part of this buy-sell agreement will be the process for deciding who is the buyer and who is the seller. This is often termed a “shotgun” provision, and it operates by allowing one person to make an offer to purchase the interest of the other partner, then the recipient will have the option to accept the purchase offer or to reject it and then become the buyer.
How this provision will work in practice therefore needs careful consideration to ensure that the business goals of the parties will be achieved if the clause is triggered in the future.
Conclusion
Starting a 50-50 owned business is exciting, but it is also inherently risky because it almost certainly requires the close collaboration of both of the partners on a long-term basis for the business to be successful. When the partners have serious disagreements, that can lead to a deadlock that cripples the business because key decisions will be postponed, investments will not be made, and opportunities will be missed. Also, the lack of clear direction when the two partners are locked in an impasse is likely to have a negative impact on both the company’s employees and customers.
If the two partners remain willing to accept these risks of entering into a co-owned business, they will want to do so with vigilance to head off future conflicts as much as possible. This planning process will require them to implement a tie-breaking process designed to resolve future disputes, as well as to negotiate and enter into a buy-sell agreement that enables them to achieve a business divorce if they reach a point where irreconcilable differences exist between them.
For both partners to keep smiling on Valentine’s Day and beyond, these planning measures will give them and the business the best chance to prosper on a long-term basis, and it will also provide a plan for a partner exit to help avoid a bitter, protracted business divorce down the road.
