Disputes between business partners are common, however, what should you do if one partner wants out? This can have lasting effects on the business and it’s most often determined by how your business agreements were written. So contract law may have a big impact on how one partner leaves a business.
This isn’t strictly something that comes up in the realm of partnerships. For the purposes of this article “partnership” and “partnership agreement” will generally refer to any type of business and agreement that involves more than one owner, so it could be an LLC or a corporation. Granted, the specifics of dissolving an LLC, corporation or partnership may differ somewhat, but the general idea here is what happens when one partner wants to leave any sort of business.
Partnerships often work out extremely well for everyone involved, but that’s not always the case. Sometimes a partner wants out and there’s nothing the remaining partners can do about it. A partner could want out for any number of reasons, it doesn’t necessarily have to be that the business isn’t doing well, although it certainly could be that. Maybe a partner just wants out to explore other opportunities, wants to retire or just doesn’t have his or her heart in the business anymore, even though it’s moving in the right direction. On the other hand, it may be something more contentious - maybe you all no longer see eye to eye on where the business is and where you want it to go; maybe the partners don’t get along; maybe, subjectively, business is bad and someone wants out as opposed to trying to fix things. Regardless of the reason a partner wants to leave, the issue remains: what do you do if one partner wants out of the business, and how do you go about ending a business partnership?
Governing Documents
The options may vary depending on the specific business entity in question (general partnership, LLC, corporation, etc.) but a good place to start is with any company governing documents that have been put in place. In a general partnership you’re looking for a partnership agreement, in an LLC it’s the operating agreement and with a corporation you’re looking for bylaws or a shareholder agreement. These documents typically contain some provisions that dictate under what circumstances a partner can leave, what the procedure looks like and often even how that partner will be divested of their ownership stake. These partnership agreements can be extremely useful when a partner wants out, they usually spell out who owns what, how decisions are made and how disputes are handled between the partners; if you’re breaking a partnership looking at these is the place to start. Unfortunately, many businesses don’t draw up the appropriate governing documents, or the ones they have aren’t customized to their particular business, making them essentially useless in many situations. While these documents can be very helpful in navigating a partner leaving the company, they aren’t mandatory in the state of Virginia, which means they are often overlooked when companies are getting started (as a side note it’s never too late to put these agreements in place). So, if your business doesn't have governing documents you move onto other available options to determine how a partner leaves, and the question becomes what happens when there isn’t an agreement to fall back on.
The State Code or Laws
In the absence of any type of governing documents or company agreements then the provisions of your states code or laws will become the default process for a partner to leave the business. For example in Virginia, there is the Uniform Partnership Act, the Virginia Limited Liability Company Act, and the Virginia Stock Corporation Act among others that govern how companies are run in the absence of internal agreements, or supplemental to in some circumstances. These rules become the guidelines your business must follow if there aren’t any agreements in place, and be forewarned, they may not always line up with the way you want to run the business, which is why the governing documents are so important. One thing to watch out for when you have to resort to the state code or laws, is that the default position in many of them is that if a partner decides to leave, then partnership dissolution is the result. This means that the company is done and will need to wind down and shut its doors. This obviously isn’t an ideal situation in any number of circumstances, even when the relationship is hostile one partner may want to continue on in the business without being forced to shut down. If you’re going to have to result to these default rules to deal with a partner leaving, and you or other partners don’t want to dissolve the business, make sure to carefully consider your options and proceed accordingly.
Negotiation
Absent an agreement that lays out what an exit looks like, you’re probably going to have to negotiate with a partner who wants to leave in order to keep the business going. Think about when they are going to leave, how much you’re going to have to pay them for their ownership stake in the company and how that ownership will be redistributed among remaining partners if there is more than one. Are you going to buy them out with a lump sum payment (a lot of small businesses can’t access capital that easily), or structure a payout schedule? Are you going to let the partner who's leaving go out and join a competing business, take all of the contacts they have made with them and any other confidential information they have? Not if you can help it, but you’ll need some agreements in place to protect the business against all of that, and limit what the departing partner can do and use in the future. If you’ve fallen into having to use the default rules from your state you’ll need to address a situation that calls for a dissolution of the business due to a partner leaving, so a separation agreement is probably in order.
General Considerations
Whenever a partner decides they want out of the business there are some general steps and considerations that should be taken to help with the process:
- Figure out how you’re going to value the business. It could be that you all agree on a value, or maybe you hire a third party to provide a valuation. Whatever the case, this will be something you’ll need to get on the same page about sooner rather than later.
- Get a handle on the company's assets and liabilities.
- Make sure you understand who owns what percentage of the business and how decisions are made.
- Document everything around the partner's exit.
- Keep records of communications around the partner leaving.
Partners leaving can be tricky situations that may need to be handled carefully in order to protect the remaining partners and the business itself. Make sure to consider all the angles.
Have questions about a partner leaving, governing documents or just general legal and risk management questions? Contact us for a free consultation.