Are you considering starting a business with a friend or family member? If operating as a partnership or LLC, a well-drafted partnership or LLC operating agreement will be crucial to memorialize your economic agreement, organizational structure and key terms, and should include provisions designed to prevent deadlock if a disagreement later arises about important business decisions.
A disagreement concerning a major decision could impede the ability of a business to move forward, placing the future of the business itself in jeopardy. Even if the deadlock concerns a less important decision, the resulting frustration can be damaging to the owners’ relationship and thus harmful to the business. A deadlock could even lead to an expensive and lengthy litigation or to the dissolution of the partnership or LLC.
Deadlock-Breaking Mechanisms
Business owners can avoid this situation by entering into a well-drafted partnership or operating agreement containing provisions designed to prevent a deadlock from ever happening. There are a variety of potential solutions, and the following are among the most common.
- Provisions Addressing Decision-Making Authority
In some situations (typically more appropriate for co-owners already having a solid relationship), the partnership or operating agreement could provide for a 50-50 split in profits, but a 51/49 split in control over decision making. Alternatively, in situations in which there is more potential for disagreement, the partnership or operating agreement could name a trusted and impartial individual familiar with the business having a two percent ownership interest who could act as the tiebreaker in a deadlock situation, but allowing the two general partners or members to retain equal ownership and control with a 49-49 split.
- Buy-Sell Provisions
A buy-sell provision spells out a means by which one co-owner will buy out the other’s ownership interest in the event of a deadlock (and in any other circumstances specified). A buy-sell provision both encourages deadlocked business owners to find a solution to avoid triggering these provisions and provides a predetermined way for one of the partners or members to exit the business in the event the co-owners are unable to iron out their differences.
These potential solutions have advantages and disadvantages: For example, when co-owners or partners have enjoyed a positive long-term relationship, having a 51/49 split in decision-making authority may seem like the perfect solution. However, there is no guarantee that the relationship will continue to be problem free. Likewise, a buy-sell provision is meaningless unless each of the members or partners has the financial ability to exercise it. It is important to carefully consider which solution or combination of solutions is best suited for your particular circumstances.
Judicial Dissolution
In most states, a partner or member may seek judicial dissolution in situations in which it is clear that there is a deadlock in the management of the partnership or LLC that the co-owners are unable to break and irreparable damage to the business is threatened or has already occurred. For most business owners, this remedy is a last resort, as it inevitably leads to avoidable legal fees and damage to the business and the relationships of the co-owners. Judicial dissolution is much less likely to be necessary when deadlock-breaking provisions have been included in the partnership or operating agreement.
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Destructive consequences can emerge if a business is structured in a way that could lead to deadlock and the partnership or operating agreement lacks provisions for resolving such an impasse. We can help you to prepare a partnership or LLC operating agreement designed to prevent this situation from arising. Please contact us to set up an appointment to discuss this or any other issues related to the formation of your new business.
