Disputes between business owners, whether they are partnership disputes, shareholder disputes or unit trust disputes, are a reality of business.
HOW DISPUTES ARISE
When a business starts the owners have enormous optimism, goodwill and mutual trust. However the reality with any co-owned business is that one owner will leave before the other. The exit of a party will be because the party no longer wishes to be involved in the business or one owner has formed the view that their co-owner is under performing and must go. All too often these issues are not addressed. There are many reasons why one party may wish to leave. In my experience the most common (but not the only ones) are:
- A desire to pursue other opportunities;
- Loss of interest in the business;
- A wish to retire;
- A view that the return they are getting is not representative of value and input to the business.
In the case of the underperforming party the reasons may be more complex but the end result is the same. They must go.
HOW TO MANAGE THE UNDERPERFORMING OR RETIRING PARTY
A decision to leave or remove a party immediately raises a number of issues.
- With the underperforming party what were the agreed performance criteria?
- With a party wishing to exit what is the agreed exit mechanism?
- Regardless of the reason for departure how is the exiting party’s interest to be valued?
- How is the interest of the exiting to be paid for?
Owners that fail to recognise and plan for these inevitabilities run a very high risk of a dispute emerging.
Whether your business is conducted through a company, trust, partnership or a combination of these it is critical that an agreement is in place to deal with the departure of one party.
When advising clients who are embarking on a business venture there are a multitude of issues to be discussed. It is not a simple process of a “one size fits all” generic document. Over time I have developed a detailed checklist of issues to be considered and discussed. However I always focus heavily on performance criteria, exit strategies and valuation.
The exiting party will always want to maximize the value of the business and the continuing party or parties will always want to minimize the value of the business.
THE CONSEQUENCE OF NOT MANAGING THE PROCESS
In my experience a failure to address these issues of performance, exit mechanism and valuation can lead to intense animosity and eventually litigation. These disputes are the commercial version of a divorce with all the associated passion. Over the years I have been involved in numerous disputes where co-owners have had to resort to the courts to resolve their conflict and to forensic accountants for an independent valuation of the business.
The most extreme case I have been involved in concerned a successful two man business. One of the parties had become disillusioned with the contribution of the other party and sought to have him removed. The party being removed was happy to go but a dispute arose about the valuation of the business. The remaining party wanted to pay nothing the exiting party wanted $2 million. Both parties spent hundreds of thousands of dollars obtaining independent valuations of the business. Ultimately a resolution was reached. Had they invested time at the outset a well crafted and tailored co-owners agreement would have included critical provisions regarding performance exit procedure and valuation methods. This would not only have saved huge amounts of money but also would have avoided all parties having to resort to litigation and the consequential time and emotional commitment involved in litigation.
BUSINESSES EVOLVE SO AGREEMENTS MUST ALSO EVOLVE
One final comment on co-owners agreements is that they are a dynamic document. As a business grows it becomes more complex and roles and responsibilities assumed by the co-owners can change. This can lead to a situation where performance criteria, valuation and exit mechanisms established at the outset may no longer suitable.
OUR FREE CHECKLIST
If you have not addressed these issues now is the time to do so. Send me an e-mail at firstname.lastname@example.org and I will forward our detailed checklist which can be used to facilitate a discussion on preparing a tailored agreement.