The Business Break-up Part I: The “Friendly” Split

Perhaps you’ve been buddies since high school or college; or maybe mutual interests or kinship brought you together. Over the years you entered into a joint venture (whether as a partnership, an LLC or a corporation). But now, for whatever reason you and your business partner have decided to part ways. Assuming you’ve agreed that you would buy him out, what things do each of you need to consider? Buying out a fellow partner can be relatively straightforward, so long as the proper procedures are followed.

1. Mutual Releases: If this is going to be a clean break, the both of you need to execute mutual releases releasing each other from any causes of action or claims you might have against the other. If this is an amicable split, it might not seem necessary, but if you’re leaving not on the best of terms, this is an absolute must.

2. Release of Company Liabilities (Seller): If you’re the one leaving the business venture, the business still might have some liabilities and debts, for which you are personally liable, such as bank loans which you were required to personally guarantee. Some lawyers simply have the buyer sign an indemnity for you, which simply means that he (the remaining partner) agrees to pay the loans, and to protect you from liability against them. The problem with this is that the bank is not bound by this agreement, and if your partner at some point is unable to make the payments, the bank can still come after you. Sure you’ve got a contract, but your ex-partner is now bust, so what good is that going to do? Instead, ensure that your break is a clean one by getting the bank to release you from your personal guarantees when you leave.

3. Proper Corporate Filings (Buyer): If you’re buying out a fellow shareholder (corporation) or member (LLC), it is important to execute the proper corporate paperwork and filings. For example, if buying out a fellow shareholder in a closely-held corporation, you need to have prepared proper corporate minutes in which the stock certificates are conveyed, and in which the seller resigns from all corporate offices, directorships and registered agency, if applicable. If the seller is a member in an LLC, you must make sure that he resigns as manager and (if there is more than one remaining member of the LLC) that all members consent to the seller leaving and to the sale, if any, of his membership interest.

Consider this example published by a colleague:

If, in your “partnership” (whether it be in form a two-person LLC, corporation or a true partnership), you believe there is beginning to be inequities in the amount of output you are producing versus the amount of profits you are receiving, you should immediately take stock of your situation. What circumstances am I talking about?
1. Perhaps your partner put up the money, and you’re doing the work; or
2. Perhaps you’re both 50/50 owners of the company, but feel like you’re putting in more time and effort, and/or are producing more profits.

The longer your relationship continues, the more “in-equity” you might build. For example, consider Mr. A and Mr. B who twenty years ago set up a two-man corporation. The corporation owns their company vehicles, their building, and some cash assets invested over the years. At the end of the year, most of the profits are taken out of the company and given in equal shares to the two shareholders.

Over the years, however, Mr. A has developed a niche market in their business. His clients and their jobs are higher-end, require more labor, but produce a larger profit. Mr. B has not grown his side of the business over the years, and in fact, has let a few of his clients drop since he’s getting older and doesn’t want to work as many hours.

In fact, now, Mr. A brings in approximately 70 percent of the company’s gross earnings, and Mr. B only 30 percent. Finally, Mr. A has enough, and tells Mr. B it’s time they split up. At this point, if the two can’t agree, Mr. A can ask the courts to split up and dissolve their corporation, pay off debts, and then divide the assets. Unfortunately for Mr. A, however, the assets will be split in proportion to stock ownership: 50 percent each; which is not in proportion to the amount worked.

Perhaps Mr. A had, when he set up his company, entered into some sort of agreement by which he could buy out Mr. B at some point. That’s savvy, but if the purchase price is determined by the company’s value, Mr. A has hurt himself by letting things drag on so long. He’s increased the value of the company by his own labor, and is now going to have to pay Mr. B a premium for his stock–stock that rose in value primarily by Mr. A’s actions!

The lesson to be learned from this story is that if you enter into a small company or joint venture, be aware that if the labor and/or production starts to skew unevenly, do not let the situation linger, or you may end up not only working harder than your partner, but one day having to pay more for the valuable product you created.

Of course, this article is a highly simplified version of the truth. Certainly proper documentation needs to be considered but the reality of any buy-out is rarely an amicable determination of the value of a partner’s interest in the company. Those issues however will be addressed in a separate discussion.

The Law Office of Jeffrey K. Davis, Esq. is a full service business-law firm dedicated to providing business owners with resourceful counsel at all stages of the business life-cycle. Providing Practical Legal Solutions. Call for a free consultation.