Operating Agreements and 50/50 Ownership
We strongly advise against holding ownership in your company 50/50 because it means the owners have to agree on every decision and we’ve seen too many partnerships like this go south, with disastrous consequences. If there is a “deadlock” (a disagreement that the parties just can’t resolve), without a written agreement, the only option may be to file for judicial dissolution, which means a judge will order the liquidation of the company’s assets, pay the debts, and split whatever little is left over. That takes time and more money and leaves the partnership and the company in the wreckage. We hate to see that, so we try to be creative in finding ways to avoid those outcomes.
Operating Agreements (“OAs”) dictate how decisions are made and what happens if the owners disagree. Therefore, an OA for a 50/50 scenario makes little sense. What value is a contract in which the parties “agree to agree?” When we are unsuccessful in talking clients OUT of 50/50 ownership, we are starting to think a better use of our time (and our clients’ money) is to work through and document a comprehensive dispute resolution process to resolve a deadlock.
What are some options?
In one OA, the 50/50 partners came up with a very simple dispute resolution process – rock, paper, scissors; best two out of three wins; company counsel referees. Cutesy and simple, but when one of the partners got into legal trouble that jeopardized the company, it wasn’t as cute.
In partnerships where each partner brings a distinct set of skills to the table, and those distinctions are both obvious and separate from one another, you can dictate that the partner with the skillset related to the dispute has the final say. For example: One partner is the detail-oriented, back-of-office operations person while the other partner is right-brained, creative, public-facing, and doesn’t know how to balance a checkbook. If the dispute relates to the choice of CPA, maybe the partner who deals with the CPA should make the call. This is a risky approach because so many decisions don’t fall cleanly into categories and using this approach requires the partners to determine their swim lanes at the outset of the partnership. It’s also highly likely that the partners will cross over in their responsibilities, so if the detail-oriented partner goes on vacation and the creative partner takes over temporarily, does that blur the lines on who makes what decision?
Another approach requires a carefully-drafted set of triggering events and a process that results. Triggering events can include material failures by one partner to carry out its responsibilities to the company (which must be previously defined), a breach of the agreement, failure to fund a capital call, or gross negligence/willful misconduct. It’s important to make sure these triggering events are as objective as possible. Sometimes “shirking your duties” is in the eye of the beholder, especially if one partner is a workaholic and the other partner actually takes weekends off. In this approach, upon the occurrence of a triggering event, the non-breaching partner has the option to exercise its choice of remedies – requiring the company to be listed for sale, dissolving the company, or buying out the breaching partner (should involve a valuation to avoid a separate dispute over the purchase price).
Others turn to mediation. Of course, you can hire a professional mediator to help the parties resolve the dispute. Mediation is often non-binding, so if the parties are really stuck in their respective camps, this might not work. In advance of a formal meditation, we often suggest, as a first step, naming a specific person who is willing to attempt to mediate the dispute. This can be the company’s attorney, CPA, or other advisor, including a mentor or industry expert that both partners respect and who can be impartial. If the company has appointed a board of advisors, that board can be the tie-breaker despite not previously participating in business decisions beyond contributing in a purely advisory capacity. We even offer a flat fee Business Partner Divorce mediation service to business owners in crisis, with the goal to find the best resolution and help the parties work together in that direction.
More formal options include buy-sell provisions. “But wait, you said the parties have to agree to agree, so what good is a buy-sell when there’s a deadlock?” In a “shotgun” buy-sell, at least the ones we’ve encountered, one partner (A) offers to buy the other partner (B) for a certain price and then B gets to decide whether to accept the offer and sell the interest, or buy A’s interest for the same offered price. The trouble with this approach is that partners often have wildly different ideas about the true value of the business. You can obtain a formal valuation of the business, but that costs more time and money and the partners remain at odds while they await the results of the valuation. When a shotgun buy/sell is helpful, it may serve only to encourage the parties to resolve the dispute because the outcome of a shotgun clause is too unpredictable.
Other things to consider when contemplating a 50/50 partnership is whether your business would benefit from disadvantaged business certifications available to companies owned by women, minorities, veterans, or members of the LGBTQ community. These are commonly referred to as Disadvantaged Business Enterprises or “DBEs” and the certification process requires that the owner who qualifies for the certification have a controlling interest in the company. Keep in mind, however, that these certification agencies go one giant step further in requiring the company’s governing documents to explicitly grant the qualifying owner carte blanche to do what they want with the company including dissolving it without having to seek approval from the other partner. To us, this sets up an unhealthy partnership dynamic because one person wields all the control and sometimes it goes to their head.
Before considering your ownership structure, also read this: Healthy Conversations to Have with Your Business Partner.