Welcome to part 2 of our series on business divorce.  Part 1 focused on understanding what a business divorce is and why it happens.  This blog is focused on preventing and preparing for potential business divorce.

As the old adage says, an ounce of prevention is worth a pound of cure.  This holds true in business divorces.  In our previous blog, we set forth the most common reasons for business divorce:  financial disagreements, unclear roles and responsibilities, differing visions, personal conflicts, and outside pressure.  Not all of these triggers can be avoided, but some steps can be taken to minimize them and prevent a business divorce if they arise.  Likewise, there are proactive steps that can be taken to make sure that any future business divorce is as painless as possible.

Fundamentally, the most important thing that you can do in this regard is to draft comprehensive governing documents – this may be a partnership agreement, an operating agreement, or bylaws, depending on the organization of your company.

Whatever form it takes, this agreement should clearly outline the terms of ownership and participation in the company and include clear provisions for what happens if one partner wants to exit or if a dispute arises. A well-drafted agreement should include:

• Ownership Interests: Define the ownership percentages for each owner. This helps avoid confusion over who owns what share of the business and can clarify the value of any future potential buy-out.
• Financing: Clearly define when additional capital contributions can or must be made, and the terms on which additional outside financing may or must be sought.
• Roles and Responsibilities: Outline the roles, responsibilities, and expectations of the owners. This prevents misunderstandings and helps ensure that each partner is clear about their obligations.This should include provisions regarding the required time commitment if any, as well as any restrictions on competition.
• Deadlock Provisions: Particularly if there are only two owners or an even number of owners, provisions should be established outlining what happens if the company is deadlocked due to disagreement, and how the deadlock can be resolved.Even with an odd number of owners, issues such as recusal due to conflicts of interest can result in a deadlock.  Including provisions to resolve a deadlock may prevent a business divorce when the owners simply can’t agree on a particular issue.
• Dispute Resolution Provisions: Even if the company is not deadlocked in its management, other disputes may arise. That’s why it’s essential to establish a dispute resolution mechanism in your governing documents. This could include either mediation or arbitration.These provisions may help prevent a business divorce, or make it more amicable should it arise.
• Exit Strategy: Establish guidelines for what happens if a partner wants to leave. This could include a buyout clause, a process for selling the business, or how shares are transferred.This exit strategy should clearly define exit triggers – that is when are owners able or required to exit the business.  These triggers will likely include provisions for involuntary exits (in cases such as bankruptcy, death, or certain acts that the other owners deem incompatible with continued ownership) and voluntary exits.
• Business Valuation and Purchase: The exit strategy outlined above should include a method for valuing the ownership interest of the exiting owners.  Common methods include book value, a formula pegged to EBITDA, an annually agreed upon fair market value, or a fair market value determined via appraisal.
• Ownership of IP: Your governing documents should also make clear the ownership of intellectual property assets, to avoid any disputes if an owner exits and protect the assets of the company.  While ownership of physical assets is frequently clear, ownership of IP can be hazier.  Accordingly, make sure to include clear guidelines as to who owns patents, trademarks, copyrights, and other intellectual property created during the course of the business and specify what happens to this IP if an owner leaves.

While no one wants to think about a business divorce when starting or running a business, preparing for the possibility is one of the smartest moves you can make. By drafting a comprehensive agreement with provisions for deadlock, dispute resolution, and exit strategies, you can protect yourself and your business to ensure that if the worst happens, the process will be as smooth as possible.

Taking these proactive steps now can save you from a lot of heartache and financial strain in the future. If you are ready to get started on protecting your business from the possibility of business divorce, the team at Way Law is here to help!