By Eric D. Morton
All relationships must end. Till death do us part rarely happens. If a business is owned by more than one person, the owners must contemplate parting ways. Of course, no one wants to think about breaking up when they start a business. However, business owners must plan for the misfortune of breaking up whether amicably or not.
There are many reasons that co-owners split up. The business may not do well. They find that they are not compatible. Their skills don’t complement each other. Owners have disagreements about money, the direction of the business, ethics and any number of issues. Regardless of the reasons, most business relationships will end.
The problem is that, unless business owners agree otherwise, they will have no mechanism to smoothly part ways. In most small businesses, the owners work in the business. They are the managers or the officers of the company. If they have a falling out and one leaves, the company is in trouble. If the owners can’t agree on how to split up, the company will probably die. Partnerships are dissolved if the partners fall out and can’t decide on what to do next. Limited liability companies can also dissolve. Corporations are in some ways worse. Without a shareholders’ agreement, a shareholder could walk out of a corporation and remain a shareholder indefinitely. These circumstances are destructive to small businesses. They can’t survive a split without a means to buy out an owner who leaves the company.
So, business owners must face up to the worst when they start out. If they don’t, then they may be stuck. Well drafted partnership agreements, operating agreements and shareholders’ agreements will provide for a variety catastrophe that can befall business owners. Typically, such agreements cover what happens if a business owner dies or is disabled. They should go much further.
These agreements should also cover what happens if a business owner stops working the company. Terms should give a mechanism for the remaining owner(s) to buy out the leaving owner’s equity in the business. These terms can differ from the buy out terms of a deceased or disabled owner’s equity. For instance, the buy out terms for a deceased or disabled owner’s equity might call for a fair market valuation of the entire company. That valuation might then be divided by the percentage of the equity interest to be bought out. Often the purchase price will be paid for by insurance.
If an owner simply stops working and leaves the company, then an agreement can have buy out terms that provide for a valuation of that owner’s interest. That valuation might be considerably less. Or, the buy out terms might be fixed price. Any way it is done, the purchase price will be an amount that the company can afford since no insurance can pay for the owner’s equity.
Going through the process of determining and drafting the terms of these agreements is not easy but it is necessary. It can mean the difference between the life and death of the company after the owners’ split. For more information about agreements between business owners, please contact us.
Eric D. Morton is the principal attorney at Clear Sky Law Group. He specializes in business law and intellectual property. He can be reached at 510-556-0367, 760-722-6582, or email@example.com.