Frequently when two people start a business, the new business partners agree on a 50/50 partnership, where they share equal authority over the operation of the business and share equally the profits and losses of the business. Even though a 50/50 split appears to be a fair way to establish the partnership, the problem with such an arrangement is every business decision now must be unanimous. When partners cannot agree on a course of action, deadlock occurs and there is no ability for one party to make any decision to resolve the disagreement.
Deadlock often carries these consequences:
• Paralysis of company operations
• Lost business opportunities
• Uncertainty among employees or vendors
• Breakdown of the partner relationship
A common way for partners to avoid deadlock is to form the business with one of the partners taking a majority 51% ownership. In order to make this work, the partner with 49% interest must place their trust in the 51% partner who will hold the veto power. Typically, the more significant financial contributor takes on the role of the majority partner.
If a 50/50 partnership cannot be avoided, the partners should adopt certain measures to mitigate deadlock. Dispute resolution and buy/sell clauses are two measures written into owner agreements for this purpose. With a provision for dispute resolution, the partners may delegate final decision-making authority to a known third party in order to break a deadlock. For example, disagreements involving distributions or other financial matters can be resolved by the company’s Certified Public Accountants (CPA).
For a buy/sell clause, a partner is enabled in the event of deadlock to offer to buy out the other partner. The other partner would then have a period of time to either accept the offer or elect to buy out the first partner on the same terms.
Mitigating deadlock is crucial for partners serious about building a successful business. These measures keep the partners out of court and their company still running.
Strobl is a team of experienced and trusted lawyers that can advise on all legal matters relating to startups and business partnerships. For more information, visit Strobl online at StroblLaw.com or on LinkedIn.