How to Break Up with Your Business Partner

Lawyers recommend that two people starting a business should not own the business 50/50 because that ownership structure sets the stage for a deadlock when the owners don't agree. Nevertheless, many business owners trust their personal relationship and proceed to set up the business as 50/50 owners. In addition, many founders of small businesses don't use a lawyer to set up their business, again, trusting on their personal relationship to help them overcome any future disagreements.

[Note: The term "partner" has a very specific definition under the law, but, for purposes of this post, I'm using the term like business owners typically use it. So, for this post, a "business partner" means a shareholder of a corporation, a member of a limited liability company, a general partner in a general partnership, or a limited partner in a limited partnership.]

One business owner will often come to me asking how they can break up with their business partner. That owner typically wants to break up with their partner because (1) they are in a deadlock (i.e., they can't agree on business decisions), (2) the other business partner has stopped contributing to the business (e.g., the other business owner has stopped working in the business without the agreement of the other partner), (3) the other business partner is taking something from the business without the other partner's permission (e.g., taking cash out, using the business's equipment to work jobs for money that the business partner does not contribute to the business, redirecting customers to another business that benefits the partner, etc.), or (4) any combination of the first three reasons.

The law does not make it easy to break up with a business partner, especially if the owners did not plan for a future breakup when they formed the business. Therefore, business breakups are inherently emotional, painful, time-consuming, and expensive.

When a business partner engages me to advise them how to break up with the other business partner, here's how I typically approach that project:

1. What are the reasons compelling the decision to break up? What has happened in the business that has brought the business partner to a lawyer for help?

   
   

2. Related to Item #1, what are the facts supporting the reason for the partner's desire to break with his/her business partner? What is the basis for the disagreement or desire to break up the business?
   

3. What outcome does the business partner hope to achieve? A business breakup can be accomplished in several different ways. Does the partner want to buy out the other partner? Or, does the partner want the other partner to buy them out? Or, does the partner want to dissolve the business, either through liquidation or splitting up assets, liabilities, and customers to each partner? Do the partners want to operate competing businesses after the business breakup?

   
   

4. What do the business's legal documents say about how to handle a deadlock or how to break up with a business owner? For a corporation, I will want to review the Articles of Incorporation, Bylaws, Shareholders' Agreement, and any other legal documents that contain terms and conditions about the governance or operation of the corporation. For a limited liability company, I will want to review the Articles of Organization and Operating Agreement for the same purposes. The legal documents most likely to contain terms and conditions about how to handle a deadlock or a breakup will be the Shareholders' Agreement, for a corporation, and the Operating Agreement for an LLC. Unfortunately, even if the business has those legal documents, they often do not contain provisions addressing those topics.
   

5. If the business's legal documents are silent or have gaps, what does the applicable statute say about how to handle a deadlock or how to break up with a business owner? Oftentimes, the business's legal documents don't contain provisions about how to handle a deadlock or a business breakup. Many times, small businesses have the legal documents necessary to start the business (e.g., the Articles), but don't have a Shareholders' Agreement or an Operating Agreement. In these instances, the dispute will be governed by the applicable statute. For example, the Virginia Limited Liability Company Act contains provisions about how to break up a Virginia LLC and the Virginia Stock Corporation Act contains provisions about how to break up a Virginia corporation. A lawyer can help you understand those statutes and how to use them to develop a strategy for negotiating or filing a lawsuit to resolve the breakup dispute.

   
   

6. What negotiating leverage does the business partner have to persuade the other partner to agree to break up the business? The reality is that almost all business breakups are resolved through negotiation because the law does not provide an efficient basis or process for breaking up the business in most circumstances. Business breakups are emotionally charged, triggering business partners to become entrenched in their respective positions and to use aggressive tactics. Company legal documents and applicable statutes and court opinions might be used to create fear in the other partner of a large potential loss. Ultimately, I have observed that resolving business breakup negotiations comes down to which party can endure the most pain (e.g., economic and emotional) for the longest period of time.

   
   

Breakup negotiations take time. They rarely conclude in a matter of weeks or even months because of the personal dynamics and emotions and personal economic costs and losses involved in breaking up the business. One of my latest business breakup negotiations lasted 3 1/2 years until the business partners signed a settlement agreement. Another has already gone on for almost 1 year with little progress toward resolution due to the posturing of one partner.

Once the partners have reached and agreement about how they will break up the business, the settlement should be memorialized in a written agreement signed by the business partners and the company (which exists separately from its owners). The settlement agreement should not only spell out the specific terms of the breakup, but also contain a mutual release of all parties. The scope of the release might depend on the facts and circumstances surrounding the reason for the breakup.

If you're thinking about a business breakup or if your business partner has initiated a breakup, you should engage a lawyer to help you understand your legal rights, develop a strategy for resolving the dispute, and to draft or review a settlement agreement to effect the breakup.

You can reach me at joel@jalawoffice.com or (757) 270-4088 if you have questions about or need help with a business breakup.