The vast majority of businesses are not publicly traded entities. They are small businesses made up a limited number of “owners.” And unfortunately, many such ventures end in a “divorce.” But what happens when this happens?
What Goes Into Resolving a Business Divorce?
There are three critical things to consider: first, the rules; second, what happens; and third, who gets what.
First, the process will likely be determined by the corporate structure and its internal operating document(s). If the entity is a corporation, the bylaws should address how one shareholder can dispose of their shares – can they be sold to a third-party, do the other shareholders have rights of first refusal, or perhaps the bylaws contain an internal dispute resolution mechanism. An LLC should have an operating agreement that serves a similar purpose as corporate bylaws.
For example, a common tool in closely held businesses is a “sword/shield” provision. As when we were kids, one person gets to break the candy bar in two, but the other gets to pick their piece; this incentivizes the first party to be fair. These provisions however can be complicated and there may be some game theory involved that will allow one side to reap a major advantage.
Second, it is possible that the parties may need to either litigate or arbitrate their dispute. A business divorce is often about more than the value of the business because one side feels that the other side acted improperly. Such conduct could diminish the value of the other’s interest while inflating the value of the actor. There can be a wide-range of potential claims, each with their own elements and issues. For example, was there a breach of contract or did one party breach a duty to the others?
Third, even when the underlying dispute can be resolved, the one thing that often causes further concern is how to value the parties’ respective interests. There is no exact way to do this: beauty is often in the eye of the beholder. And unlike publicly traded companies, there is not a defined market that can set value. How the interest is valued can vary based on the industry and other distinct factors and hiring an appropriate valuation expert can be critical.
Further, if the interest is a minority interest (less than 50%), the owner may not be able to actively participate in the management or control of the company. Therefore, a minority interest may be seen as less valuable and subject to a “discount” – a 20% interest in a company worth $10,000,000 may be worth less than its $2,000,000 prorated value.
Although a business “divorce” may seem simple, this is not always the case.
If you have further interest in these topics, please feel free to join Aaron when he is a featured presenter for Lorman’s Continuing Legal Education webinar, Navigating the Complexities of Litigating Jointly Held Business Disputes, scheduled for January 17, 2017, from 1:00 pm to 2:30 pm. Click here, for more information about the presentation. If you would like to participate in our Friendship discount, you will find a code at the link above, or if you have questions regarding this or our other webinars and presentations, please contact Melanie Yonks at firstname.lastname@example.org for more information.