Business disputes happen. The key to ensuring your business remains successful is understanding how to prevent and diffuse these disputes when they occur.
The “50/50” Deal & Other Deadlock Situations
When two or more people decide to start a business together, they often choose to split everything evenly: contributions, distributions, and voting rights (known as a 50/50 deal). One of the most common issues for these types of companies is when there is an even split among the owners about what action to take. This results in no decisions being able to be made. In most cases, the company’s governing documents don’t cover deadlock events.
When this occurs, and no paperwork is in place or it is silent on the issue, some tips to help resolve the deadlock include:
- Appointing a non-executive director
- New class shares being issued to an independent professional
- Appoint an expert in the field to make decisions
If someone opts to exit due to the deadlock, there are several options besides court/legal action, such as:
- Buyback in the company’s name
- Buy or sell shares subject to a valuation
- A third-party buyer
The ultimate remedy for this issue is court action, but should be avoided, as it is also the most expensive solution.
Duties Owed to Other Partners, Owners and the Company
Co-owners of a business owe each other a duty of managing the business for the benefit of each other, and no owner may take any action that would be detrimental to the other owners. This is known as a fiduciary duty. The co-owners of a business are obligated to deal with one another in a fair, honest and open manner. Business owners must actively protect one another’s interests and avoid personal advantage at the expense of their partners.
If a partner pursues something that advances their own interests, but not the interests of all the owners, it can lead to a breach of fiduciary duty. This can be avoided simply by not pursuing any action that would not benefit all owners and not keeping information from each other.
Salary vs. Distributions
As a business owner (whether it is a corporation, LLC or partnership), you are eligible to receive an income distribution when your company makes a profit. For C corporations, these distributions are known as dividends, and they may be paid out to the shareholders or they may be reinvested in the company. For LLCs, Partnerships and S corporations, the income is distributed to the owners according to the partnership or operating agreement or based on the percent of ownership they have in the company if there is no agreement.
Owners of certain business entities must also receive a reasonable wage/salary if they actively participate in the day-to-day management of the business. Failure to do so could result in a visit from the IRS.
The Operating Agreement
If you have a business, you likely have an operating agreement in place. Absent a valid operating agreement, your business will be subject to the default rules established by state law that are frequently much different than what you want. The operating agreement outlines the functional and financial decisions of a business, including provisions, regulations and rules. The main purpose of this document is to regulate and to govern the basic, internal operations of a business in a manner that meets the needs of the business owner or owners.
Some of the items included in the operations agreement include:
- Distributions & Waterfall Provisions
- Voting Rights
- Additional Owners/Members
As you can see, there are a wide array of things to consider when starting a business. It may be necessary to work with a professional like The KC Estate Planner to ensure you have all of the needed documents in place.