The best way to deal with the any change is to plan for it. The best practice is to have an agreement between and amongst the partners as to what happens with respect to different events. When planning, there are a number of clauses which should be included in the agreement. The names of these agreements vary depending on the type of entity you have but the types of provisions are all the same:
1. Buy-out provisions. There are a number of times when one or more partners desire to leave the business or simply want the other partner out. This may include one partner leaving the business completely, or simply ceasing employment with the organization but retaining ownership in the company.
Who has the right to trigger a purchase? What is the mechanism to trigger a purchase, and how and when will it happen? What happens in the event the purchase is triggered, but the sale does not close? Can an owner force another owner to buy out his interest? These are questions that should be addressed.
2. Misconduct or lack of performance. There are often times when a partner does not live up to expectations, for whatever the reason. The reasons range from lack of a good fit to ordinary malfeasance. Oftentimes the owner/partner is also an employee of the company, drawing a salary in addition to whatever bonuses or dividends are paid out.
What is agreed to if it is determined that, as an employee, the party should no longer be employed? Will the termination of an employee cause a buy-out of that person’s ownership interest?
3. Death or disability. Sometimes one partner becomes disabled and is either unable to continue at the former pace or unable to continue altogether. Before agreeing to enter into the business to begin with, the partners ought to determine what they want to happen. The choices include allowing the disabled partner to continue to receive all benefits that she had prior to the disability regardless of the ability to work to having some type of forced buyout of that partner’s ownership interest. The types of buyouts are limitless and vary from a single cash payment requiring the other partners to put up capital or borrow money to purchase the disabled partner’s membership to payments over time.
The same is true as to when a partner dies. Along these lines, the partners also have to discuss whether the death or disability of a partner simply terminates the business. This also raises insurance issues. Should the company carry key man insurance? Key man insurance is simply life insurance on the key person in a business. In a small business, this is usually the owner, the founders or perhaps a key employee or two. Should the company carry disability insurance for the important parties?
4. Ability to sell ownership interest. Another issue that should be addressed is whether a party’s membership interest can be sold to another party, and if it can, do the other owners have a right of first refusal to buy that interest. This issue can arise if one of the parties is going through a divorce and the ownership interest is subject to division in the dissolution proceedings. The non-owner spouse will generally be entitled to some portion of the value of the membership interest.
Can the interest simply be transferred to the divorcing non-owner spouse so that a party who was not an owner can then become an owner without the consent of the initial owners?
Agreements are easier to make on your honeymoon than they are during your divorce. Careful planning can help establish the expectations and rules when it comes time to parting ways with your partners.
M. James Zendejas is a partner at the law firm Stinar Zendejas & Gaithe PLLC. His phone number is 719-635-4200.