In recent years, headlines have carried news of high-profile splits between business partners at private companies. These business partner consequences include:
- 2023: Sam Altman is ousted as CEO of Open AI (for less than three days) before making a dramatic comeback to the company where he remains today.
- 2022 Republic First Bank CEO Vernon Hill resigned after a months-long power struggle with insiders, including bank founder Harry Madonna.
- Also in 2022, real estate developer Steve Ross, chairman of New York-based Related Companies, ended his longtime business relationship with partner Jorge Perez, chairman of Miami-based Related Group, to which they publicly said was friendly.
- Finally, in 2020, Forbes reported: “Perhaps no duo on Wall Street has risen higher and split faster than the partnership between billionaires Robert F. Smith and Brian N. Sheth, co-founders of Vista Equity Partners.”
Reflecting on these separations of business partners made me think of Leslie Gore’s golden oldie, which remains popular today: “It’s my party and I’ll cry if I want to.” These high-profile splits between business partners make for obvious headlines, but with some planning they can be avoided. Even when a business divorce becomes necessary, it should not result in tears and trauma for the partners or their businesses. In this new post, we explore steps business partners should consider that can help avoid conflict, but will also provide a more peaceful path to an exit if one partner ultimately decides to leave the business. .
Essential terms of the written document
The venerable Western saying is that good fences make good neighbors. In business, good deals make good partnerships. To avoid/reduce conflicts, business partners should set out their agreements in key terms that address who controls the business and its operational structure. These conditions include: (1) who decides key issues such as compensation, (2) whether to issue executive bonuses and distributions/dividends to owners and in what amounts, (3) whether key company decisions must be made by a simple majority of owners, with the unanimous consent of all owners, or with a super majority percentage, (4) if the decision-making structure can lead to a deadlock between the partners on key decisions, what mechanism exists to allow the partners to overcome impasse (a third party is likely to be necessary) and (5) whether to appoint and give authority to independent board members or managers who can provide objective information to the partners (co-owners) about important issues.
No business runs without facing challenges, some quite serious. For business partner owners to overcome these challenges, they will be greatly helped if they have established a decision-making structure that includes third parties that provide input and recommendations based on their past and experience. Further, partners who look ahead and seek to reach agreement on management and control issues in the business before conflicts arise can avoid more serious disputes.
Negotiate and approve a business prenup
There are many anecdotal stories about business partners who worked together their entire adult lives after starting a private company before eventually selling it or passing it on to their children. These are heartwarming stories, but they are the exception, not the rule. In most cases, business partners do not stay together for decades; instead, partners will come and go, and transitions are not unusual. For this practical reason, business partners should consider entering into corporate prenuptials with each other when the company is first formed or when a new business partner makes an investment in an existing business. This is an opportune time to enter into this type of agreement that regulates the exit of a partner as they are focused on the future success of the company and generally have a positive view of each other.
There must be a mutual interest from both company owners and investors to enter into this corporate prenup, which is generally set out in some form of a buy-sell agreement (BSA). For majority owners, the benefit of securing a BSA is that it provides the owner with the authority to extinguish the ownership interest of a minority partner even if that partner does not wish to exit the business. No majority owner of a private company wants to be stuck in business with a minority partner who is dysfunctional, disruptive or, worse, directly interfering with the operation of the business. Therefore, the BSA provides the majority owner with a “call right,” which allows the owner to secure an involuntary exit of the minority investor if the need arises.
For minority investors, the BSA will also provide them with an extremely important benefit. Specifically, the BSA provides the minority partner with a guaranteed way to monetize his or her ownership interest in the business. In the absence of a BSA, the minority investor will not have the right to exercise a “putting right” to obtain a redemption, and therefore the investor may be stuck for years holding an illiquid ownership interest and indigestible in the company.
Negotiate a BSA that meets the needs of all partners
The BSA will address all of the following issues: (1) when it may be triggered by the majority owner or investor, (2) how the value of the minority ownership interest being redeemed will be determined, (3) how Payment to be structured to the investor for the interest held in the business, and (4) what dispute resolution procedure will govern the implementation and enforcement of the BSA between the partners.
These issues must be addressed at the outset of the investment and must be carefully evaluated to meet the business objectives of both parties. For example, the parties may decide that the BSA cannot be activated for several years after the investment is made. This is referred to as a “delayed scaler”, which will allow the company time to grow in value after the investment is made before it can be bought or sold. Therefore, both the majority owner and the minority investor may be required to wait three, four or even five years before either party can pull the trigger to redeem the interest held by the investor or to secure a buyout of the investor’s interest. business investor.
Since the majority owner also has a right of repurchase, the investor will want to be sure that the majority owner’s right to redeem (buy out) the interest held by the investor in the business is subject to a “look-through” provision. This term protects the investor in the event that the business is sold not long after the investor’s interest is bought out by the majority owner (review provisions often last at least a full year after the investor’s buyout takes place). If the business is sold during the review period for a higher value than the investor received in the repurchase, this provision will require the majority owner to issue an actual payment to the investor to ensure that the investor receives the benefit of highest rating. which was achieved when the business was sold.
CONCLUSION
Breakups of business partners will continue to make headlines, especially when they involve high-profile figures in large companies. But business partners who engage in advance planning and take steps to address internal governance issues can avoid conflicts that lead to a business divorce. This type of advance planning, including the adoption of a well-drafted BSA, will also reduce pain and headaches if a business divorce becomes inevitable.
