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 Sharp 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 Sharp online at StroblLaw.com or on LinkedIn.