By Brian Fisher
“We are friends (or family), we will just work it out.” Words most transactional attorneys have heard when advising a client that ownership of an entity on a 50/50 basis, without a tie-breaker provision, is a recipe for disaster.
Imagine for a minute that you and your best friend decide to form a company for the purpose of operating a widget producing business. Both you and your friend put in 50% of the start-up capital. It makes sense that you and your friend should each have a 50% vote on all decisions regarding the company, right? Yes; however, what happens if you and your friend cannot agree on a business decision? Well, a deadlock occurs and, if there is no method to break the deadlock, it is possible that the business comes to a screeching halt, putting both you and your friend (and each of your livelihoods) at risk.
Such a deadlock can be addressed incorporating one or more of the following into the entity’s governing documents:
A buy/sell provision whereby one party can affix a value to the interests in the company and offer the other party the right to buy the offering party’s interest or sell the other party’s interest to the offering party based upon such value. This is the most common method of resolving a deadlock. There are several different ways to structure such a provision; however, the intricacies of such a provision go beyond the scope of this article;
Appointment a third (3rd) party to break the deadlock. This is not such a common method of resolving a deadlock as it puts the decision in the hands of a third party who has no vested interest in the company;
An arbitration provision. This is not common as arbitration is time consuming and costly. Most times, business decisions cannot wait for arbitration to run its course;
A mediation provision. Mediation is cheaper and less time consuming than arbitration; however, mediation (unlike arbitration) is not binding. Thus, a resolution is not guaranteed; or
A dissolution provision whereby either party can elect to dissolve the company. Obviously, this is a remedy of last resort; however, if neither side is willing to concede, this may be the only option.
The moral of this story: you and your friend should have clear 20/20 vision at the outset of the business relationship as to how deadlocks will be resolved. While it is quicker and easier (and sometimes cheaper) on the front end of a deal to not address this sensitive issue, at the end of the day, doing so will save you money, frustration and quite possibly a relationship.