No one goes into business thinking that disagreements with partners or shareholders will one day threaten the enterprise they've worked so hard to build. But, as with many promising marriages, business breakups do happen. What is vital is knowing how to split without putting your "baby"—the business itself—at risk.
In my experience, there are several basic types of business breakups. Seeing the patterns and identifying these case archetypes can give you some clues about how to help a client traverse this journey.
Archetypical Case Types—Do You Recognize These?
The company founder who won't let go. In this classic case, a single founder starts a company and brings in two or three individuals, developing them to be partners in his firm. At some point, he decides to sell stock to them, after which he no longer owns a majority share—but he still thinks he's in charge. He believes he's entitled to make the business decisions. That can tee up a major conflict between the founder and the new shareholders.
The older generation who transfers unequal shares to the younger generation. This can happen either during life or as part of an estate plan. I've worked with clients to address situations where parents give shares of their business to all of their children in equal parts, but later reconsidered after only some of the children were actively participating in the company. In such cases, I've assisted the perceived "non-involved" children as the parent went about redeeming those shares from them—which can be a highly contentious process.
The 50-50 founders who disagree. Another common type of case is one in which two founders or groups of founders have different goals or different timelines. Companies in which the ownership is split 50-50 are always at risk of deadlock when there is a disagreement. One side can never out-vote the other.
Expanding on the last archetype, the 50-50 split, let's examine a hypothetical case to help illustrate the issues involved and what to consider while guiding your clients.
Hypothetical: Brothers vs. Sisters and the Family Farm
This fictional dispute, created using aspects of real events (while keeping the clients anonymous), features a closely held family farm corporation with extensive real estate holdings. Four siblings—two brothers and two sisters—own the stock. The brothers work inside the business and each holds 25%. The sisters don't work in the business and each owns 25%, as well. That gives us a 50-50 split between the insiders and the outsiders.
The sisters have alleged oppression because the family corporation was paying their brothers what they deemed to be excessive wages while not paying any shareholder dividends, and the brothers refused to provide their sisters with financial and other information about the corporation and the real estate holdings.
While neglecting to pay dividends, the brothers used the profits to expand the family business by purchasing additional real estate, something the sisters were not aware of—and did not approve.
What did the sisters do, then, to make a living? They started a competing farming business with their spouses. They offered to sell their shares in the family business, but their brothers refused, arguing the price was not dictated pursuant to their governance documents. The articles of incorporation, in fact, included a book value formula and a corporation right of first refusal before a shareholder could sell his or her shares. Accordingly, the brothers, as part of the negotiations, offered to purchase the shares at slightly above book value, but the sisters turned them down.
Where Do We Go from Here?
Clearly, the four siblings are at a standstill, and there is no mechanism built into the corporate structure to resolve it. A good attorney can approach this conundrum in a number of ways.
One approach that is often used when the buy/sell agreement is being drafted and the parties are all happy with each other is the so-called Russian roulette clause, in which one party sets a price for selling its shares and the other party must either buy or sell at that specified price. Even if this doesn't resolve the stalemate, it is useful in an agreement because it often will jump-start a discussion among the conflicted parties.
Other helpful approaches may include:
- Fact-finding. Ideally, this begins with the initial meeting with a client. The attorney must understand who the client is—is it the company? Is it the company and the insiders? Is it all shareholders? What has the history been?
- Digging deeper. When confronted with shareholders who are stuck, an attorney may want to probe. The attorney must figure out what questions the clients aren't asking. What are their goals and priorities? Sometimes just posing open-ended questions can unlock insights about the clients, their thought process, or some perceived slight from years past that is getting in the way of consensus. Disputes are seldom limited to what appears on the surface.
- Some clients, like those in our hypothetical, may make decisions without fully appreciating what their legal duty is to shareholders and the company. The brothers in our fictional case may not know the term "fiduciary duty" or understand how their actions could impact their sisters. They may assume they know what's best for everyone, which helps justify, for them, the withholding of information. That, in turn, can stoke distrust on the part of the outsiders. Holding regular meetings of shareholders in family corporations or other privately held companies, and issuing regular reports, can help avoid contentious disputes. As attorneys, it is our duty to educate clients on these basic issues.
- Calling a joint meeting. If the opposing sides have not been meeting regularly, consider whether a joint meeting might be helpful. Provide an agenda in advance and talk with opposing counsel to set the stage. In the mediation world, this is called a caucus, and it can be quite effective.
- Getting an offer on the table. Work with your client(s) to come up with an offer they can live with and see if that sparks a negotiation. It may not happen on the first, second, or even third attempt, but presenting something concrete can set things in motion.
- Bringing in a mediator. Getting a mediator to the table can be another catalyst for discussion and agreement. Even if the deal doesn't settle on the mediation table, a skillful mediator often helps the parties to set the stage for a later agreement.
Working through high-stakes business disagreements takes dedication, patience, and a thorough understanding of the client. Taking the time to learn about a client's motivations and carefully explain the law are vital to resolving these disputes—and helping keep the business alive.
This article appeared previously in Hennepin Lawyer.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.