You’ve set up your company, everything is great, and you and your business partner are ready to move forward as equal partners! But there’s one thing you may not be thinking of in this honeymoon stage of your business – deadlock.
Deadlock is what happens when two equal (50/50) business partners disagree on a major decision and can’t move forward until the decision is resolved. If you do not have a defined mechanism to deal with the situation, and neither partner is willing to give, then the only means of resolution is for a court to get involved and dissolve the company (a result nobody sees as ideal).
Assuming you and your partner want to have equal ownership (and voting) rights, here are a few ideas and solutions you may consider when setting up your business.
You may consider mandating in your governing documents that you and your partner negotiate when deadlock occurs through a defined process, which may include, for example, participating in good faith in mediation. You and your partner would sit down with the mediator who would work to facilitate a discussion between you and your partner and try to guide you to an agreement. This sort of requirement would often be supplemented by another requirement which describes how things will be resolved if mediation does not result in resolution.
Third Party Vote/Arbitration
You could appoint a neutral third party to cast a vote if a tie comes up without making this person a formal member of your LLC or director of your corporation. This third party could be named in your governing documents, or you could spell out a process for identifying the third party. The same effect could also be achieved through arbitration where each partner present its arguments to an arbitrator who has the authority to issue a legally binding decision. This process may follow a requirement to first negotiate and/or participate in mediation.
MAD (Mutually Assured Destruction)
This option serves more as a deterrence than anything else. The idea is to build in mechanisms or solutions to deadlock in your governing documents that are bad for everyone thus encouraging you and your partner to avoid deadlock at all costs.
Another option is to write into your agreement that you and your partner will flip a coin or draw lots to break the tie. Leaving the decision up to chance may or may not be to your liking. However, it may serve as more of a deterrence than anything else.
One Cuts, One Chooses
You could also work into your governing documents that if deadlock becomes so bad, you and your partner will partition the company. In order to try and make it as fair as possible, you could decide to have one partner split the company but the other partner choose which portion to keep. This option may not be very helpful if your company is difficult to divide up.
This option is to allow one partner to sell his or her portion and the other partner to buy it. There are a variety of creative ways to do this and in any scenario, you would need to be thoughtful about the mechanics for purchase to ensure that the process can actually work in practice (for example, you may want to specify that the purchase can be done through a combination of cash and debt in the event that the partners may not have sufficient funds for an all-cash purchase). Here are just a few of the many options for pursuing a buy-sell in the event of deadlock:
In a deadlock situation, this provision would require a partner to send a notice to the other partner naming a price at which he or she values a half interest of the partnership. The partner receiving the notice can either buy the other partner out or sell out to the other party at that named price.
Texas Shoot Out
Here, each partner would send a sealed all-cash bid to some sort of neutral third party stating the price at which they are willing to buy out the other party. Whoever made the higher bid “wins” and must buy the other partner’s share in the business.
Purchase at Fair Market Value
Here, one partner will trigger the buy-sell option by sending a notice to the other partner. Once it is triggered, a third-party will determine the fair market value of half of the business. Then the partners can attempt to agree on who will buy the other partner’s stake in the business. If the partners cannot agree, then a coin flip can determine who will be the purchaser and who will be the buyer.
Adjusted Fair Market Value
Here, one partner will trigger the buy-sell option by sending a notice to the other partner. Once it is triggered, a third-party will determine the fair market value of half of the business. After valuation, the partner who triggered the option must either buy all the other partner’s shares at some premium (such as 125% of the fair market value) or sell his or her shares at some discount (such as 75% of the fair market value).
DISCLAIMER: The information in this article is provided for informational purposes only and should not be construed or relied upon as legal advice. This article may constitute attorney advertising under applicable state laws.
Photo Credit: USFWS / Ann Hough, National Elk Refuge Volunteer