Protect yourself from a 'business divorce'

Jan. 1, 2020
When business partners decide they no longer want to work together, the result can be a contest fought as bitterly as the most acrimonious divorce.

When business partners decide they no longer want to work together, the result can be a contest fought as bitterly as the most acrimonious divorce. Sometimes, no matter how much money you offer your partner for the business, it's not enough. But when you offer to be bought out instead, any amount is too much.

The circumstances behind such stalemates are varied, but one common denominator is the partners didn't plan. Here are some tips on how to avoid a "business divorce."

  • Choose your business partners carefully. Be sure you have compatible goals, values and management styles. If your goal is to be the largest independent aftermarket retailer, you are setting yourself up for failure if you go into business with a partner who wants a nine-to-five lifestyle. Put your agreed-upon goals and values on paper and discuss them annually. If you disagree later, you will have some previously agreed-on common ground.
  • Have an exit strategy. The time to decide when to exit the business is when you start the company. You can always agree later to revise your exit strategy.
  • Know what your business is truly worth. You should know what your business is worth — and what you will do if you are approached with an offer.
  • Set clear ground rules. Establish company policies regarding issues like who can be an owner; minimum requirements for family members to enter the business, such at least four years' experience at a company where your last name doesn't mean anything; each partner's areas of responsibility; and limits on each partner's authority.
  • Establish a buy/sell agreement. A buy/sell agreement is a contract among the owners of a closely held business. That provides for a smooth transition in the event of certain events, such as:
  • Death — A buy/sell agreement can provide liquidity, as well as the assurance that your family won't be subjected to the risks of owning a business run by others. Life insurance can help fund a buyout and provide stability to the family of the deceased partner and will keep the buyout from damaging the business. A buy/sell agreement can also guarantee that the surviving owners do not suddenly find themselves with unwanted new partners.
  • Disability — A buy/sell agreement can provide economic stability to the disabled partner and his family when they need it most — and keep the business from having to support a partner who no longer is able to contribute. Again, insurance can be an important component.
  • Divorce — A buy/sell agreement can help ensure that ownership of the business is kept in the family.
  • Retirement — A buy/sell agreement can provide a mechanism for an owner to retire, while restrictions on ownership transfers ensure there won't be destabilizing transfers to unknown third parties or interests pledged as collateral for loans.
  • Serious disagreement among partners — A buy/sell agreement can outline what to do when partners reach an impasse and avert bitter fights that can destroy a business.

A buy/sell agreement answers questions such as when can a partner leave voluntarily, who buys his or her shares, to whom a departing owner may sell and if owners should have the right of first refusal if a partner tries to sell shares to a third party.

How should you value your business?

A buy/sell agreement provides the framework for establishing the value of the ownership interest being transferred. How can you provide an accurate valuation for your company?

Valuation formulas can be straightforward and simple. For instance, the business might be valued as a percentage of sales or a multiple of net income. However, the percentage or multiple that provides an accurate estimate of value today probably will not be right tomorrow as the economy, your industry, your business and the market for selling businesses changes.

Some companies decide they will obtain a valuation if the buy/sell agreement is triggered. A valuation can provide an accurate, up-to-date value, but a valuation can be expensive. If your business is large enough, a valuation makes sense. However, if the valuation clause of your buy/sell agreement isn't well-written, it's an invitation to litigation. The valuation clause should answer questions such as:

  • Who will perform the valuation?
  • What standard of value will apply?
  • Will you apply any discounts, such as for lack of marketability or control?

Some buy/sell agreements have a standoff clause that allows one partner to set the price and the other partner the choice of being the buyer or the seller.

What if you're already in a dispute with your partner?

It's important to understand what each of you want and need. What caused the rift? Are there any unseen motivators, such as a partner wanting his child to run the business? Can the business be split up? The process will go more smoothly and you'll save money if you hire one valuation expert to work for both sides as opposed to each side hiring its own expert.

Put aside your emotions and prepare to give and take. Otherwise, you may wind up in court, which can cost hundreds of thousands of dollars, take years to resolve and cause the business to deteriorate. Many times, it's useful to have a third party experienced in dealing with business breakups mediate the discussions to keep them on track — and act as a referee if needed. And of course, if you don't have a buy/sell agreement, get one now — before you need it.

Patrick F. McNally, MBA, CPA, ABV, is Partner in Charge, Corporate Finance Consulting, for Blackman Kallick in Chicago. He can be reached at (312) 980-2934 or [email protected].