Business divorce, just like traditional matrimonial divorce, can occur for many reasons. Many times, business divorce is occasioned by underperformance and the need to separate an underperforming owner. However, the opposite circumstance, a business that has done well, can also spur desire for change in structure. Just like matrimonial divorce, business divorce can be a long, painful and expensive proposition. Consideration of trigger events for dissolution and setting an exit strategy before commencing the business venture can manage the expectations of the parties and facilitate transition when it becomes necessary. And it almost always does.
One of the primary considerations is trust. Consider the level of trust you place in a business partner on so many levels. Trust ranges from the basics of whether you can trust your partner not to have a hand in the cookie jar, to more esoteric questions of whether you can trust your partner to share your long term vision. All too often clients come to us with stories of unexplained payments for personal expenses which are only discovered by accident. What are the rights and obligations of the company and the business partners in such event? These rights should be spelled out in the agreement between the parties, otherwise the company, and the innocent shareholders, are left to argue common law claims and may be without a way to specifically extract the untrustworthy owner.
Trust goes deeper than the simple situation of defalcation (misuse of funds). Can you trust your business partner to have the same desire to grow your business and increase sales and performance metrics over an extended time? Business entities generally have perpetual existence. Can you trust that your partner will continue to make the requisite investments of time, energy and money that are necessary to bring the success you work so hard to achieve? If the agreements between the parties do not provide for a mechanism to remove that partner, or at least monetarily induce that partner to voluntarily separate, what strategy is available to accomplish the necessary change?
If extraction of a non performing owner is one side of the coin, the terms of voluntary separation are the other. Even in the absence of material differences between owners and managers, time and circumstance often require parties to go their separate ways. The terms of voluntary separation can be every bit as complex as forcible removal. Often, the most problematic inquiry is the right to be compensated in consideration of separation. Such terms of separation can vary based on valuation methodologies such as “market” or “book” values, timing of payments, reductions or additions to value based on subsequent conduct. In the absence of advance planning, the parties are almost certain to find dispute.
Post-employment obligations and fiduciary duties are also fertile ground for dispute. Corporate officers and directors have fiduciary obligations to the business. Partners, shareholders and members may have fiduciary obligations to each other. A departing shareholder may or may not be permitted to directly compete either during or after termination of the business relationship. Certainly, issues arise with respect to client/customer relationships and confidential information. More substantial issues may arise when the business develops a new technology or intellectual property which one party seeks to exploit in a different way. Agreements between the parties can address such possibilities and preserve rights by contract which might otherwise be ambiguous.
What if it all goes wrong? Again, business entities are generally established to have a perpetual existence, so termination must be accomplished by agreement or statutory procedure. What kind of consent is necessary to effectuate dissolution? Must all of the shareholders or members agree? Agreements can specify events and effect of dissolution including specific assignments in distribution of assets according to differing methodologies or factual circumstances. In circumstances where one party is opposed to liquidation or dissolution, the situation can become even more complex. Occasionally, only the appointment of a receiver can effectuate liquidation or dissolution; a generally unappealing circumstance as such an appointment necessitates the loss of control.
The questions posed and circumstances described above underline the importance of careful consideration prior to establishment of business entities. Such considerations during the business “engagement” and before business matrimony are necessary to prevent significant hardship when expectations are not managed. Advance planning though counsel can address many of the issues potentially faced by business owners and help the parties realize their expectations when circumstances change.