Despite attorneys crying ‘beware of the 50/50 partnership,’ business owners often find themselves, and insist, on that exact relationship. ‘Fifty-fifty seems right,’ they say. ‘We are immune from the pitfalls that plague others.’ In my experience, 50/50 partnerships (especially when a business is just starting) are a reality. A good attorney, however, should have the tools ready to help those eager business owners avoid the most common problem of a true fifty-fifty relationship: unresolvable deadlock.
Of course, ‘fifty-fifty’ is itself a vague term, and when business owners say they want to own the business fifty-fifty, a good attorney should seek to clarify whether they mean that voting power will be split evenly between both of them, or, as they more often mean, rights to the distributions of the profits will be split evenly among them. Owners can be surprised to learn that in limited liability companies – or LLCs, the form most new businesses operate under- an owner’s voting rights do not have to be proportionate to their rights to receive distribution of the profits. Reallocating these rights and powers may be a good first step to help fifty-fifty owners avoid (otherwise almost inevitable) deadlock.
But even if the owners insist on maintaining both fifty-fifty voting power and distribution rights, there are a number of provisions available that owners can request their attorneys insert in their business’s operating agreement (which governs the operation and management of LLCs) to help avoid and/or resolve deadlock in a fair and quick manner.
- Day-to-day management. Perhaps it is the intention of the owners that only one of them will be running the business on a day-to-day basis. If that’s the case, the operating agreement should so state, and possibly should include a list of specific actions the day-to-day managing owner can take without the approval of the other owner. Setting this out on the front end will help define the expectations and understandings for both owners and keep the more silent partner out of the other partner’s hair. Certain major decisions (i.e., the sale of substantially all of the assets of the business; taking out a loan in excess of $X) could still require the approval of both owners.
- Simple and practical dispute resolution provisions. More times than I can count, owners have handed me previously drafted operating agreements that contain burdensome, overly formal and expensive dispute resolution procedures (that is, if the operating agreement even contains a dispute resolution procedure). These provisions often state that disputes will be resolved by a mediation and/or arbitration process. As legal professionals should now be aware, these procedures can be time-consuming, drawn out, and unnecessarily expensive. In small to medium size businesses with only two owners, these types of dispute resolution procedures do not reflect the on-the-ground reality for how the owners would actually prefer to resolve disputes. For day-to-day decisions, I find it is almost always cheaper and more agreeable to delegate final decision-making authority in the event of a dispute to a known third-party who would have expertise resolving that specific matter. For example, matters involving calculation of expenses or distributions might be better resolved by the business’s CPA. Other disputes involving internal procedures and duties might be better resolved by the business’s attorney. Valuations and appraisals should be conclusively resolved by one or more appraisers with expertise in the area. Only if there are certain decisions that the owners believe cannot be resolved adequately by a third party should the more formal dispute resolution procedures be available.
- Restrictions on Transfers. The company’s operating agreement should probably also restrict an owner from selling all or any portion of his or her ownership interest in the business to a third party. An owner likely doesn’t intend to go into business with someone they would have no say in selecting. On top of this, if the business does not have an operating agreement (which is surprisingly common), the other owner is free to transfer a portion of his or her interest to another party and, more importantly, under Georgia’s default laws, each owner would have one vote (regardless of how much of the business each owner owns). Under this circumstance, an original owner could be outvoted on every single decision by the other two, one of which the original owner did not choose to be a co-owner with. This is a type of deadlock resolution possibility that the two original owners likely did not want or intend when they started their business.
- Deadlock Buy-Sell Provisions. Wherever there is a possibility of deadlock among business owners, their operating agreement should provide a mechanism that allows either of the owners to leave the business fairly in the event of a deadlock. One of the most effective mechanisms is a deadlock buy-sell provision, which allows one owner in the event of a deadlock to make an offer to the other owner to purchase that owner’s interest in the business. The other owner would then have a period of time to either accept the offer and sell the interest or flip the offer and purchase the offering owner’s interest. In theory, because the other owner has the opportunity to flip the offer, the original offer will be a reasonable and fair estimate of the value of the ownership. These provisions work better when the financial means of both owners is similar, although the provision can be revised to account for many different circumstances.
These are just a few of the ways business partners can help avoid and fairly resolve deadlocks that may arise in the operation of their business. These provisions can always (and should) be tailored by an attorney to account for the issues specifically confronting each set of owners. If you and your business partner are considering a 50/50 partnership or need assistance drafting an operating agreement or putting these protections in place, please feel to reach out to me directly.