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Tough Talk: Exit-Planning Strategies for Business Partners

Tough Talk: Exit-Planning Strategies for Business Partners
Business Attorney Houston

Drew Erickson

Associate
It’s never a fun conversation, but it’s always an important one: discussing options to exit your business with your business partners. This conversation can get lost in the excitement of starting a new business (or joining an existing one), but getting on the same page with your business partners at the beginning is vital to protecting your interest in the business (and protecting the business itself).
While it seems counterintuitive to discuss ways you may want to leave your business when you join as an owner, there really is no better time to discuss these exit-planning strategies than at the beginning. By not having these conversations, it’s likely that an exit event will occur at some point, and when it does the exiting owner’s interest will inevitably be adverse to the business and the other owners. With this in mind, it’s much better for all parties involved to negotiate and agree on the events and terms for a partner to exit the business at the beginning while everyone is rowing in the same direction, as opposed to waiting until necessity dictates this conversation be had when everyone’s interests may not be aligned.
While this article won’t go into each and every potential exit event, there are two distinct categories of events that business partners should discuss and agree to in a written agreement: (1) voluntary exit events and (2) involuntary exit events.
A voluntary exit event is an owner’s affirmative decision to leave the business for any number of reasons, including:

■ Wanting to retire and have the business redeem your ownership;

■ Desiring to sell to another partner of the business, or desiring to be bought out by another partner; or

■ Finding a third party not associated with the business that wants to buy you out and take your place with the business.

With any voluntary exit event, the main decision point to discuss is the ownership vote needed to approve any event. If an owner wants to sell to a third party not associated with the business, does it take a simple majority of the owners to approve the sale? Supermajority? Unanimous? Does the selling owner’s vote count towards the approval? These are all questions that should be asked, answered, and agreed to in a written agreement before such an event can occur. The other big question to discuss is whether the business and/or business owners have a right of first refusal upon a voluntary exit event (e.g., before selling to a third party, does each owner have a right to pro ratably buy out the exiting partner?). This is important for business owners because it gives them the right to keep the ownership team the same if they choose to, as opposed to an owner selling to a third party who the other owners may not know (or may not want to be in business with if they don’t have the votes to veto the sale).
The other major category of events is an involuntary exit event, which is an unforeseen or unplanned event that affects a business partner, which includes:

■ Death;

■ Disability;

■ Divorce (which if a partner lives in a community property state may grant such partner’s spouse a fifty percent ownership interest in the partner’s interest in the business)

■ Bankruptcy; or

■ Finding out a partner has committed “bad acts” against the company, like embezzlement.

With involuntary exit events, the discussion should revolve around first identifying all such events, then detailing what rights are created as a result of an event occurring (e.g., whether the other partners and/or the business have an option or obligation to buy out the partner subject to the involuntary exit event), and then determining a purchase price, payment terms, and whether any premiums or discounts are to be applied. The purchase price and payment terms can be different depending on the event – death can be paid through life insurance proceeds if taken out on the lives of the partners, a forced buy-out of a partner who committed bad acts can have a discount applied to the purchase price and may be paid out over a longer term of years than other events, etc.
It’s easy to see how acrimony can develop after an exit event occurs without having a prior agreement in place dictating the terms on how to address such an event. And being the partner who brings these issues up at the beginning of a relationship with your business partners conveys thoughtfulness and forward-thinking, which are desirable traits for a business owner. The Pros of creating an understanding among the business partners and stability with your business absolutely outweigh the Con of having a “tough talk” with your business partners.
DISCLAIMER
Rapp & Krock, PC presents the information in this article for general education purposes only. Although this article discusses legal issues, it is not legal advice. The law and the content of any linked website may have changed since this article was written, and Rapp & Krock, PC makes no warranty or guarantee about the continuing accuracy of the information presented. Use of this article does not create an attorney-client relationship, and Rapp & Krock, PC does not represent you unless and until we are expressly retained in writing.

Copyright © 2020 by Drew Erickson. All rights reserved.