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Are you considering starting a business with a friend or family member? A great business idea and someone you like spending time may not be enough to ensure you can successfully do business together. If you plan to form a partnership, you should take steps to properly organize the business into a legal entity – likely an LLC, but sometimes a corporation or other entity. You’ll also want to make sure that you have a well-drafted, custom governing document called an Operating Agreement. These documents memorialize the terms of your agreement with your business partner, the organizational structure, and key terms like tax status and allocation of profit and loss, If drafted properly, they also include provisions designed to prevent deadlock if a disagreement later arises about important business decisions, which is especially important if you plan to have a 50/50 partnership.
As the business grows and big decisions need to be made, a disagreement could impede the ability of a business to move forward. Even if the deadlock concerns a less important decision, the resulting frustration can be damaging to the owners’ relationship and thus harmful to the business. A deadlock could even lead to expensive and lengthy litigation or to the dissolution of the company.
Business owners can avoid this situation by entering into a well-drafted operating agreement containing provisions designed to prevent a deadlock from ever happening. There are a variety of potential solutions, but the following are among the most common.
- Provisions Addressing Decision-Making Authority In some situations (typically more appropriate for co-owners already having a solid relationship), the operating agreement could provide for a 50/50 split in profits, but a 51/49 split in control over decision making. Alternatively, in situations in which there is more potential for disagreement, the partnership or operating agreement could name a trusted and impartial individual familiar with the business having a two percent ownership interest who could act as the tiebreaker in a deadlock situation, but allowing the two general partners or members to retain equal ownership and control with a 49/49 split.
- Buy-Sell Provisions A buy-sell provision spells out a means by which one co-owner will buy out the other’s ownership interest in the event of a deadlock (and in any other circumstances you may want to discuss in advance – like death, disability, divorce, bankruptcy, retirement). A buy-sell provision both encourages the deadlocked business owners to find a solution to avoid triggering these provisions, but if they can’t work out the disagreement it provides a predetermined way for one of the partners to exit the business.
These potential solutions have advantages and disadvantages: For example, when co-owners or partners have enjoyed a positive long-term relationship, having a 51/49 split in decision-making authority may seem like the perfect solution. However, there is no guarantee that the relationship will continue to be problem-free. Likewise, a buy-sell provision is meaningless unless each of the members or partners has the financial ability to exercise it so you want to make sure that it is properly funded and your partner’s finances are sufficiently in order. It is important to carefully consider which solution or combination of solutions is best suited for your particular circumstances.
If you don’t have an advance agreement in place, and it is clear that a deadlock can’t be resolved without irreparable damage to the business, then a business owner partner may seek judicial dissolution – i.e. the judge will decide whether the company should be terminated and how assets and debts of the business will be divided. For most business owners, this remedy is the last resort both because litigation is very expensive, and because the business and co-owner relationships will be extremely difficult to repair. Judicial dissolution is much less likely to be necessary when deadlock-breaking provisions have been included in the partnership or operating agreement.
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Whenever you enter a partnership, you’re hoping for the best for the success of your business. However, you and your potential partner should also plan for the worst. Littleton Legal PLLC can help structure a business plan that includes provisions to prevent deadlock situations from arising. Please contact us at 918-608-1836 to set up an appointment to discuss this or any other issues related to the formation of your new business.