There are two times that business partners argue: when they have money, and when they don’t. Those alternatives cover all available time segments, so if you’re advising people on how they should organize their business, some rules for the arguments may be in order.
The classic horror story about such arguments is the Illinois appellate case Hagshenas v. Gaylord,199 Ill App 3d 60, 557 NE2d 316 (2d D 1990) where Larry Hagshenas eventually paid more than $600,000 in legal fees and judgments because he left Imperial Travel in Bloomington, Illinois. Imperial had four owners, and each of them had a girlfriend, and they all hated each other — but he, a 25% owner, couldn’t get a local court to dissolve the entity. So he opened a competing agency across the street. His former associates sued, and won, with the court saying he had a fiduciary duty not to compete so long as he retained ownership, even with no right to make entity decisions.
We fixed the Hagshenas problem with amendments to the Illinois Business Corporation Act, 805 ILCS 5/7.90, that let owners opt out of management functions to avoid liability. The same protection already existed in our Limited Liability Company Act, which limits fiduciary duties to members acting as managers, see 805 ILCS 180/15-3(a)-(g). The late Lin Hanson wrote an excellent article summarizing these changes for our Institute for Illinois Business Laws, available at http://ilibl.files.wordpress.com/2011/12/ibj-article-june-2011.pdf.
Which brings me back to buy-sell agreements. These are what owners should have in place, to cover things that happen to us all, eventually:
Death: Here, “key man” insurance can cover a buyout of a member’s interest if he or she dies, and is deductible as an entity expense, unlike individual purchases of life insurance. The buy-sell needs to either make the insurance amount all that is payable, or to define how owner’s percentages of the company are valued.
Retirement: Whole life insurance, SEP plans, IRA’s, ESOP agreements with employees to buy the company, and a variety of other tax-advantaged savings industries exist to help with this, but most companies don’t throw off enough cash to cover all family needs. At this point, a sale of the company may provide the cash. The buy-sell can be keyed to existing pension, profit sharing, or other arrangements, but also needs to provide for how owners can or cannot force sale of the whole megilla. The usual rule is that majority owners decide, and minorities get paid a fair share for their part of the enterprise, by preset percentages or a valuation process or by sale prices and post-sale employment arrangements.
Resignation: Hard nosed owners want to be paid their accumulated shares of value even if they commit felonies that take down the company. Majorities like to be able to force misbehaving owners out with nothing more than their original cost for membership interests. Non-misbehaving owners want to leave with a fair share of accumulated profits, and/or of enterprise value when they leave. The resignation rights (if any, and often limited to a period after the initial investment has built a building, or otherwise created an ongoing business, like five year LP exit rights events), valuation process (could be annual, might be tied to specific plan milestones), and reasons for different levels of payout are all negotiable parts of a buy-sell.
Disability or Divorce: Nobody wants to be in business with hostile strangers. Buy-sell parts of LLC operating agreements, shareholder management rights or voting trusts agreements in corporations, share transfer limits in ownership grants, and many other similar instruments usually limit spouses to dividends or other payouts when the other owners decide to make payments. This may be a mistake. In many “Mom and Pop” companies — and 3/4 or so of all US businesses are family owned — the spouses may want the other spouse to take over if they are disabled or die. If they fight, though, they and their partners may want to trigger an exit or buyout. Distribution rights until sale, and decision rights, all are again active negotiation items for the buy-sell agreement.
The fundamental lesson is simple: figure out how to get out of any business deal when you’re making the original deal, and you still like each other. After that, feel free to argue, fight, and leave, but do so within the agreed rules of engagement.