Mountain Law: Breaking up a business: The need for an effective exit strategy
It can be so hard to keep a business going that owners often neglect to consider how the business will end. Yet not having an effective exit strategy can be a disaster. Here are some things to consider:
Regardless of whether a business is a corporation, limited liability company or partnership, the owners of the business should have an agreement addressing – among many other issues – how the owners will handle certain “triggers” that lead to the end of the business or the departure of an owner. Triggers leading to the end of a business might include it no longer serving a purpose, lacking resources to continue, or selling to another company. Triggers that lead to departure of an owner might include the owner’s retirement, end of employment, death, disability, divorce, or bankruptcy. There is no “one size fits all” arrangement to address these triggers; it depends in each case on the needs of the owners and nature of the business.
One common feature of an exit strategy is a buy/sell agreement defining the circumstances under which an owner could buy or sell her interest in the company to or from another owner. A difficult part of a buy/sell agreement is determining a fair price. The agreement could state a fixed price or a method for determining the price such as a formula or appraisals. Another option is a “push/pull” arrangement in which one owner could offer to sell her interest for a certain price or to purchase the interest of another owner for the same price, and the other owner would be obliged to buy or sell for the stated price.
In addition to deciding how price will be determined, owners should consider how a buyout will be funded. For example, a business may wish to purchase insurance for each owner that can be used to buy out that owner’s interest in the case of death or disability. Lack of funding for a buyout can lead to unnecessary acrimony between the owners.
A frequent issue is how to handle ongoing business when one owner departs. As an illustration, a recent case called LaFond v. Sweeney involved one partner leaving a law firm that was working on certain cases and the remaining partner completing the cases on his own. The issue was whether the departing partner was entitled to a share of the profits made from the cases. The partners had a general agreement before the business ended that they would split all profits equally, but the remaining partner argued that he should get the money from the cases because he did the work. The court disagreed and found that, because the cases were started while the business was ongoing, they were company assets that had to be split equally according to the partners’ agreement. The partners could have changed this result by making a different agreement before the business ended.
Another common issue is whether an owner should be permitted to transfer her business interest to a third party and, if so, whether the third party should be able to participate in management of the company (in addition to sharing profits); whether the remaining owners should have a right to approve the third party; and whether the remaining owners should have a right of first refusal that would permit them to buy the interest in preference to the third party.
Owners should ideally agree to an exit strategy at the time they start doing business with each other, but it can be done later. Owners should review any agreement periodically to make sure it continues to address their needs. An experienced attorney can help work through the issues and draft an effective agreement.
Noah Klug is principal of The Klug Law Firm, LLC, in Summit County, Colorado, and focuses his practice on business, real estate, and litigation. He may be reached at 970-468-4953, or Noah@TheKlugLawFirm.com.
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