FIVE WAYS TO AVOID A COSTLY BUSINESS DIVORCE

       The business divorce, when business partners see no option other than to wind things down,  can often be the most costly and time consuming form of litigation perhaps running a close second to the husband and wife divorce.  Sometimes it is inevitable that business partners need to split; however, there are certain things that can be done, at the beginning of the business or even after it starts, in order to avoid intra-business disputes from degenerating into a costly and elongated conflict winding up in the court system.   Here are some ideas.

  1.             Sign a Written Shareholders Agreement.

     It never ceases to amaze me how many business owners fail to execute a written Shareholder’s Agreement.  Virtually every business divorce case that I have handled has one element in common – – there either is no written Shareholder’s Agreement or the one which has been executed is incomprehensibly complex and no one, including the lawyers involved in the subsequent lawsuit, actually understand it.  

    Moreover, handshake deals, even among the best of friends, are generally a bad idea.   No one will remember the agreement the same way in the event that a dispute arises later.   Accordingly, putting the agreement down in writing is the best idea and could ultimately serve as a tremendous cost saver.

     Some business owners seem to understand this concept but, nonetheless, either refuse to pay the money for an attorney to create such a document or simply pull a form from the internet and then do it themselves.   A Shareholder’s Agreement, even in a small business, can be a complex legal document.   Pulling one off the internet, and drafting it yourself, is a really bad idea.   The reason for this is that most form Shareholder’s Agreements are written in incomprehensible jargon which no one understands at the time they review and/or sign it.   Naturally, this circumstance makes the later interpretation of the document almost impossible.   What were you thinking and what did this mean?   Most often, I am greeted by a blank stare from a client when I ask this question, particularly when the agreement is several years old at the time that the conflict boils over. 

2,  Determine In Advance How Profits Will Be Divided.

You will be surprised how many businesses fail to do this before the business starts.   At the end of the year there is an often massive scramble (what I call the arm wrestling contest) to determine who gets the gelt[1].   The properly drafted, executed and reviewed Shareholder’s Agreement should address this issue so there are no surprises.           

 

3. Real Equity versus Sweat Equity.

     Many business owners who lack sufficient capital to invest attempt to obtain “Sweat Equity” in a business.  The problem is that it is relatively easy to measure the contribution of real capital into a business (it is objective) but the measurement of sweat equity is a far more perilous task.   How do you determine the value of someone’s labor?   Real labor does, in fact, have value.   The question is how much?

     The Shareholder’s Agreement can value this by ascribing a dollar value to the amount of hours expended starting and ultimately running the business.   However, this is something which has to be carefully monitored or it can be subject to abuse.  In any event, the important thing is that the contributions of all participants need to be measured in some objective fashion so, at year end, appropriate determinations can be made as to how profits are split.             

4. Control of the Money.

     Controlling the money is often the most important aspect of any business.   First, and this may be obvious, you should trust the person who has control over the bank account and, in most businesses, it often pays to require more than two signatures on any check.   In this manner, communication among shareholders is often required before expenditures are made.  This will reduce tension at the end of the month when one partner says to the other something like:  “Why did we pay this?  Why did we buy this?   Why did we spend this?”   The better approach is to have that discussion before the money is spent, rather than after.   Two signatures on the checking account will help solve this problem.

     Someone needs to check the bank statements every month to make sure that no one is stealing (the bookkeeper, for example).   Permitting an employee to steal is one of the best ways to ensure the destruction of the business and you would be surprised at the elaborate schemes employees develop in order to do this clandestinely.   This can be avoided with careful oversight of expenditures and revenue.   These responsibilities can also be spelled out in the Shareholder’s Agreement and should be

5.    Corporate Opportunities.

     All the parties need to understand exactly what the business does and what its opportunities are.   A question often arises when an opportunity presents itself in a related business and one shareholder takes that opportunity for him or herself.   While this is almost always frowned upon, you would be surprised to hear the creative explanations offered by shareholders as to why the corporate opportunity taken does not relate to the company’s business and, as a result, was not really an opportunity of the company.  Corporate opportunities should be directed to the company itself, not the individual shareholders.   Thus, a well drafted Shareholder’s Agreement will define exactly what the company’s business is and may delineate, specifically, what opportunities belong to a corporation and what opportunities do not.

     A carefully drafted Shareholder’s Agreement can cost anywhere from between $2,500.00 to $15,000.00.   A litigation involving a matter with no Shareholder’s Agreement, or a poorly drafted one, can cost anywhere from $30,000.00 to $250,000.00 or more.   Compare the cost and make your own decision.   Almost all of the business divorce cases we handle come from parties who either have no Shareholder’s Agreement or present us with a Shareholder’s Agreement for review, executed without counsel’s input, which is vague and/or ambiguous.

     Putting the terms of your business agreements with shareholders in writing could ultimately save you time, money and a lot of unhappiness.


[1] Gelt is the Yiddish word for money. http://www.merriam-webster.com/dictionary/gelt

1 Comment

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One response to “FIVE WAYS TO AVOID A COSTLY BUSINESS DIVORCE

  1. Id have to check with you here. Which is not something I usually do! I enjoy reading a post that will make people think. Also, thanks for allowing me to comment!

    Like

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