When the shareholders of a business can no longer work with each other without serious disagreements and acrimony, the business and the value of each shareholder’s interest in the business will quickly deteriorate, especially if no shareholders’ agreement exists to provides a method of resolving a disagreement. This is perhaps the most critical reason why shareholders should attempt to work out the terms of what is to happen if a dispute arises, well before there is a dispute.
Unfortunately many corporate partnerships find themselves in a situation where the parties can no longer work with each other, there is no shareholders agreement and instead of focusing on a solution to the problem, the parties end up pointing fingers at each other which just results in further deterioration of the relationship. In many businesses that are owned by two or three persons who contribute equally to the business, emotion gets in the way of looking for a business solution that preserves the business value created by the parties.
The difficulty in finding a workable solution, in many cases, is that each of the parties thinks that, whatever they agree to, they will be giving an advantage to the other side. Righteous indignation gets in the way of financial common sense, and each of the parties may proceed on the assumption that if the go to court for a solution, the judge will believe them and see the justification in their position. That is a completely misguided view, and most reputable lawyers will try to dissuade a client from this way of thinking unless the opposing party absolutely refuses to cooperate. Judges don’t care who’s right or wrong except in the case where one of the parties has been dishonest or has attempted to exclude the other party from equal participation in the business. In these circumstances the result will generally be that each party will spend anywhere from 50,000 $100,000 (and in many cases much more) on legal fees and valuations, and, win lose or draw (there is usually no draw), neither party will really be happy at the end of the day.
If the parties are unable to negotiate a solution, several alternative solutions can be considered.
The Shotgun Buy-Sell Agreement
This ominous sounding form of agreement is one in which the parties agree that one of them can set a purchase price per share (or a price for a block of shares), which then obligates the other party to make the following choice: either purchase the other person shares at the price they have named or sell their shares to the person who was initiated the buy sell on the basis of the same price per share. There are a number of ancillary requirements that have to be met, such as repayment of shareholder advances, and the agreement sets out the terms under which the sale will take place, usually including a period in which the seller agrees not to compete with the business.
Several years ago, a client consulted me about a demand that his 50% partner had made that, if he didn’t enter into a shotgun buy sell agreement, his lawyer would bring a court application to order the imposition of a buy sell agreement. In response we agreed that we would prepare a shotgun buy sell agreement, but would not initiate the shotgun. That turned out to be acceptable to the disgruntled partner that initiated the threat, with the result that my client had the benefit of considering whether to sell at the price named or to buy. The only point that could not be agreed upon was the period during which the seller would be prohibited from competing with the business or soliciting any employees or customers. The other party offered one year and we wanted five years. As a result, a court application was made to request that a judge impose an appropriate non-compete period. The overall cost for this approach turned out to be a fraction of what both clients would have spent if the relationship had been the subject of litigation.
In cases where the parties are unable to agree on who will be obligated to initiate the shotgun, that issue could be settled by a coin toss, ensuring that the result of the coin toss can be enforced.
Private Auction
A second and less commonly used solution involved a private auction with only the parties being entitled to bid. This procedure requires that an independent person be retained to act as auctioneer. The documents required to implement this consist of an auction agreement, and two agreements of purchase and sale, one agreement being implemented if party A is the successful bidder and the other if party B is the successful bidder. A coin toss determines who is to bid first, with each successive bid required to be an agreed minimum above the last bid. The amount of the minimum bid is usually based on the overall estimated value of the business. For example, if the value of the business is relatively low, say $500,000, minimum increases could be between $5000 and $10,000 with the minimum increasing with higher values. The bidding continues with 5 to 10 minute intervals between bids until one of the parties fails to put in a competitive bid within the time limit or accepts the last bid made by the other party.
Apart from the advantage of this alternative avoiding litigation, the parties have more control over the outcome than in the case of a shotgun arrangement. In preparation for the auction each party can prepare their financing arrangements, determine the value of the business and how high they are prepared to go before they will accept a buyout, and have a financial and legal adviser available to assist in the process. The best comment that came out of the use of this procedure was when one client, who ended up selling, said “I’m not really happy being the seller, but I feel the process was fair.”
Not all disputes between business owners can be resolved without litigation. When emotions and irrational mindsets come into play, many parties are unable to let go of historical resentments and other roadblocks that get in the way of sensible decision-making. The biggest mistake that the business owner can make is to fall in love with their business and fail to accept that resolving a disagreement between shareholders, in most cases, should just come down to money. Any other attitude will generally succeed in putting money into the pockets of lawyers, accountants and valuators.
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