The Academy

Breaking Up Is Hard To Do...Even In Business

In any relationship where people are mutually dependent on one another for their continued survival, the potential for conflict is high. Going into business is certainly no exception. It should be no surprise, therefore, that opportunities for friction and discord among joint business owners abound. Accordingly, parties should go into business with good controls in place to dictate how matters will be handled when the inevitable conflicts arise. With a thoughtful approach by the parties at the outset of the new venture, a well-crafted owners’ agreement can establish an agreed upon and binding process for addressing and resolving key decisions and conflict.

Of course, conflict among business owners can be avoided entirely by not sharing ownership. However, sole ownership of a business is not desirable or feasible for most new business owners. A successful new business requires three ingredients—Talent, Money, and Operations—often in the form of three (or more) joint owners. Talent and Operations lack sufficient cash to launch the venture on their own, so they inevitably bring Money in as an owner. Money has neither talent nor operational skills in the business, so she needs Talent and Operations to make the business work. Talent may be skillful or artistic in the business, but he needs Operations to take care of all the business activities that he cannot (or will not) do himself. At this point, the interests of all the parties--Talent, Operations, and Money--are aligned, and they each recognize the need for and value of what the other owners bring to the table.

Joint business owners typically don’t start off predicting disaster. They go into business with great excitement, enthusiasm, and the expectation that their business plan is going to produce great results and be successful. They have joined forces with people who share their vision and passion and show the same enthusiasm and commitment to the business. Over dinner, drinks, and 1000 text messages and emails, Talent, Operations and Money develop the business plan, come up with the perfect name for the Company, assign roles, and make many other decisions necessary to the start-up. As with many relationships, each member is assuming the best about each of the other owners, and for a host of reasons, they avoid having any difficult discussion which might cast a cloud over this very exciting time or derail the business. As a result, the parties typically decide that they will all be equal owners, they call an accountant, form the company with the requisite state authority by the filing of the minimal organizational documents, set up a bank account, put in their cash, sign a lease, and—voila!--they are in business.

The owners next decide to engage an attorney because “they want to do things right”. That attorney—who represents New Co., and not any one of the parties--is engaged to prepare an owners’ agreement. As such, the attorney chooses a neutral form owners’ agreement—one that treats each of the owners the same--and circulates it to each of the owners for review and comment. The attorney explains to the owners how the provisions of the owners’ agreement generally function, answers the owners’ questions (if any), and, with minimal discussion and almost no revisions, the owners execute New Co.’s owners’ agreement.

As time goes on, conflict among joint owners can arise from many different sources: personality conflicts, differences in the vision for the business, greed accompanied by a power grab, and perceived inequities in the owners’ respective roles and contributions. When conflict arises, the owners start to think about things in a very different way than they did in the sunny days when the company was formed. That change in perspective causes the owners to look at the owners’ agreement in a very different context. For perhaps the first time, individual owners may ask “What can I do if I disagree with my partners?”, “What can she do if she wants to pull out?”, “What can they do if they all vote against me?”, “Will the business survive?”, “Will I lose everything?”

In their review and discussions about the owners’ agreement, joint business owners typically focus on certain provisions: the percentage interest of each owner, the means by which New Co. will be managed (by the members, by a manager, or by a board of managers), each owner's role in the operations of New Co., and whether the cash that each owner contributed will be treated as either as a capital contribution or a loan. Armed with that understanding, the parties get to work and New Co. is in business.

As time goes on, conflict among joint owners can arise from many different sources: personality conflicts, differences in the vision for the business, greed accompanied by a power grab, and perceived inequities in the owners’ respective roles and contributions. When conflict arises, the owners start to think about things in a very different way than they did in the sunny days when the company was formed. That change in perspective causes the owners to look at the owners’ agreement in a very different context. For perhaps the first time, individual owners may ask “What can I do if I disagree with my partners?”, “What can she do if she wants to pull out?”, “What can they do if they all vote against me?”, “Will the business survive?”, “Will I lose everything?”

An owners’ agreement is the place where the owners’ can head off avoidable disputes before they happen and create the framework for resolving unavoidable disputes. Common provisions in owners’ agreements dictate:

  1. What activities of New Co. require a vote by the owners to approve,
  2. What happens if an owner wants to sell their interest in New Co. to a third party,
  3. What happens if an owner dies or becomes disabled.
  4. What happens if an owner’s equity interest in New Co. becomes subject to creditor claims (i.e. filing for personal bankruptcy by an owner),
  5. What limitations are there on an owner’s ability to pledge their equity interest as collateral for a loan,
  6. Can New Co. employ an equity owner, and if so, what happens if New Co. fires them as an employee,
  7. What events would cause an owner to have to involuntarily sell her interest to New Co. or the other members,
  8. How an equity interest being sold be valued and what the terms for payment of the purchase price will be,
  9. What percentage of the equity must vote to approve certain significant actions by New Co., such as selling all of the assets, taking out a significant loan, amending the owners’ agreement, or dissolving New Co., and
  10. What percentage of the equity must vote to approve either a distribution of profits to the owners or require the owners to pay additional capital into the Company.
As an owner, the owners’ agreement can be a dual edged sword. In one place, the owners’ agreement supports your position, but elsewhere it allows most owners (which might not include you) to amend the owners’ agreement without your consent. An owners’ agreement might provide for New Co. to employ you and other owners, but it might also provide that you may be fired (by majority vote) and your ownership interest bought out, again without your consent. By majority vote, the owners could be required to pay additional money into New Co. (a capital call), and if you do not or cannot pay your share, the owners’ agreement says that your ownership interest will be re-allocated to any owner(s) who do make that capital call; effectively forcing the sale of some, or all, of your equity interest, also without your consent. These things could be authorized by the owners’ agreement, which you agreed to at a time that you did not think any of it was possible or likely.

Regardless of the nature or source, when equity owners have conflict, if New Co.’s owners’ agreement does not provide good procedures for addressing the situation, then the owners are left with the singular avenue of commencing litigation. Business litigation is expensive, emotionally taxing and can result in the complete dissolution of the company. Accordingly, it is important that the owners ask the hard questions when going into the relationship, contemplate what a break-up would look like, understand their rights and duties, and get an owners’ agreement that is tailored to their specific needs, and provides the best structure possible to facilitate the operation of the company and a framework for the resolution of conflict.

Article written by Michael Long and sourced from Forbes