The Dangers of Fifty-Fifty and How to Avoid Them
Many businesses are owned “50-50,” for a multitude of reasons — perhaps the entity was initially formed or inherited by two parties, or perhaps the entity’s ownership structure changed during the life of the business leaving two partners. While “partners” can mean the owners of a traditional partnership, the entrepreneurs in a joint venture, or owners in a legally recognized entity, like a corporation or a limited liability company, the problems of equal ownership don’t really change.
Equal partners often fail to maintain the formalities of a governance procedure for resolving disputes — such as establishing a buyout mechanism — as would owners who were not founders but rather found themselves joined together by circumstance, without emotional ties to keep their business venture afloat.
One obvious problem in a business equally owned by two parties is deadlock or stalemate. Deadlock can be deadly; it can grind a business to a halt, create (often extreme) dissension between partners and/or lead to litigation — including “business divorce.” Business divorce litigation can run the gamut of court actions: removal and/or disassociation of partners; a compelled buy-out of a complaining partner; dissolution or sale of the underlying business; appointment of a “third-party tie breaker” (whether a third director in a corporation or an interim receiver or manager in a corporation or LLC); and/or claims of one partner for money damages for the alleged bad acts by the other. A business divorce can become the ultimate business problem, when partners can’t reconcile their differences.
Partners without a plan for navigating an impasse before they begin working together run the risk of destroying not only their partnership, but also the value of the business. Either way, without some mechanism for reconciling disputes, the risks of doing business increase dramatically, along with the risk of business divorce litigation — which too often takes on a life of its own, irreparably destroying relationships of formerly content partners.
The absence of a controlling interest by one partner vis-à-vis another partner is amply demonstrated by immeasurable deadlock cases — all of which have one common denominator: governance documents and structure which lack resolution mechanisms. Without such mechanisms, depending on the degree of disagreement and/or dissension, partners can be left to their own devices to seek satisfaction. In some cases, partners resort to “self-help,” — looting the business — sometimes directly and at other times by starting a competing business. In other situations, partners end up in heated litigation. This can often become the case in family disputes, which can grow even more complicated if trusts for passing wealth through generations are involved, as the interests of subsequent generations become relevant. Sometimes later generations have minor interests in the business at hand, leaving intact the fundamental equal ownership dispute, but requiring complete participation of the business’s other minority interests in business divorce litigation.
If your business is 50-50, if you intend to enter into such an arrangement, or if you anticipate that such could occur (due to the imminent or eventual retirement of a third partner, perhaps) you should consult knowledgeable counsel to negotiate and design a governance structure that allows for the resolution of deadlock. One approach is to enter into a “business prenuptial agreement” detailing how the partnership will be unwound, under what circumstances, and by whom if the partners cannot agree on important issues. For example, corporate partners might agree that any deadlock dispute be submitted to mandatory mediation and/or arbitration, before invoking a “buy-out remedy,” which would allow a complaining partner to exit the business, on certain terms, for fair value. In an LLC, the entity’s Operating Agreement should provide a similar resolution mechanism, while also outlining an agreed-upon process for the appointment of a third-party manager to resolve fundamental disagreements.
Alternatively, whether the business is operated as a joint venture, partnership, corporation or LLC, the partners might structure a mechanism to dissolve and split equally the value of the business, subject to offsetting claims to be resolved by mediation and/or arbitration.
If partners are unwilling to commit to such alternative dispute resolution procedures, they may be instead willing to agree to limit the scope of dispute resolution, such as waiving any right to a jury trial and/or limiting the types of disputes that can be brought to court.
Imagination and creativity are required in structuring a business relationship (whether existing or contemplated), so that partners feel each will receive a “fair shake,” should disputes arise. Further options can include a dissatisfied partner disassociating from the business after receiving fair value for his/her investment (in a global sense); mandatory business counseling (a service offered through most major business and/or law schools for distressed business ventures); or an agreement effecting an orderly liquidation and wind-up of the business, so that each partner can feel that he or she exited the business “whole.”
The moral of our story: provide concrete pathways early on for addressing and resolving deadlock situations, before business relationships become complicated, and you can avoid messy business divorce litigation.
For those interested in further discussing this article, feel free to contact Fred Mendelsohn at email@example.com or at 312/840-7004.