How do I get rid of a business partner that’s driving me crazy?

QUESTION:

I have a startup, and my business partner is driving me nuts. What are the options I have for getting rid of him or separating the company into two? I’d like to know what other people do in this type of situation, so I can approach it in the right way. Thanks for saving my life!

ANSWER:

Ethan Stone

Ethan Stone

by Ethan Stone, Stone Business Law

First, a quick but important clarification: I’m not your lawyer and this answer doesn’t establish an lawyer-client relationship. I’m giving a generic answer to a generic question to educate the users of this site.

I’ll assume, in answering this question, that the founders didn’t plan for departures and separation when the formed the business. That’s generally a good idea (see my discussion here http://www.foundersspace.com/business/whats-the-best-way-to-bring-on-a-partner/), but if it wasn’t done, it can’t be helped.

I’ll also assume that the separation will be by agreement of the parties, rather than by legal maneuvering. If the parties can’t agree and a non-consensual solution is needed, the possibilities and the outcome will depend on how the form of business (e.g. corporation, LLC or partnership), where is was formed (e.g. Delaware or California), what, if anything, the governing documents say on the question, and what the parties have already said and done. If the situation is headed for a fight, an experienced lawyer needs to look at all the details and help develop a practical strategy. There might be a relatively easy way to sideline the troublesome person. If one of the parties is truly irrational, however, fights are likely to end up in court or festering for a long time without any resolution. In the worst case scenarios, the rational option may be to move on to a new business idea with different founders and an important lesson learned. Court cases can hold up the business for years and can cost much more than the parties are likely to get out of them.

With those assumptions, it’s important to focus on the problem as separation between people who aren’t seeing eye-to-eye, rather than “getting rid” of someone. The practical upshot may be the same, but psychology is important. If you want someone to reach agreement with you, it’s usually best not to make them think you’re trying to kick them out. If the other person gets their back up, it will be much harder to agree on anything down the line. Be aware of the strengths of your position (if there are any), but don’t get carried away. It usually costs money to enforce your rights and fighting is generally more expensive than agreeing. Revenge and domination can be emotionally satisfying, but they’re rarely good business.

So let’s assume the co-founders are practical people who realize there’s and problem and are capable of talking reasonably about solutions. There are several different ways to separate:

The simplest is for one founder to stay and the other to leave completely. In most cases, this means paying something to the departing founder. It may make sense to let the departing founder keep a minority equity position. The advantages are that the remaining founders don’t have to come up with cash, the parties don’t have to agree on what the business is currently worth and the departing founder can hold on to some hope of profiting from the business. The downside is that a disagreeable outsider will remain inside the business. It’s possible to control the risk with a shareholders’ agreement. For example, the departing founder could agree to vote with the remaining partners on director elections and major transactions. But equityholders always have some ability to make trouble, so a clean separation is best. If the parties can agree on a price but don’t have much cash, it’s worth considering paying the departing founder with a promissory note. If the business plan calls for outside investment from angels or VCs, however, using debt requires some thought. On the one hand, angels and VCs take a dim view of using their investment cash to pay off long-gone founders. On the other hand, they also don’t like troublesome stockholders hanging around. Ideally, the note should be freely pre-payable and the remaining founders should be prepared to pay it out from their own cash, if necessary.

If you can’t agree on who should leave, the next thing to consider is splitting up the business. Whether this is practical or not, depends entirely on the business and the founders. Typically, the main issues you need to address are dealing with the property (physical and intellectual), the co-founders’ future business activities, and the employees (who is going with which founder). Try not to get bogged down in false either/or decisions. It’s often practical to share the use of property through leases and intellectual property licenses. Likewise, it often makes sense for both founders to carry on the same business in different geographical areas, different industries or different applications. Just make sure the separation is clean enough that you won’t be getting in each other’s way.

It’s worth emphasizing that a competent lawyer is necessary in a situation like this to make sure whatever is done cleans up the mess, rather than making it worse. Getting a clean, enforceable separation that will produce the results you want (including tax implications and title to IP) is simply not an easy DIY project. It is best to involve a lawyer before starting serious discussions, to make sure the discussions proceed in legally workable ways.

Ideally, each of the separating founders should have a separate lawyer. If that’s not practical, the lawyer will generally insist on representing only one person in the transaction. That person might be the business entity, rather than one of the individual founders. FYI, a lawyer who doesn’t bring up this issue at the outset is probably not competent.

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Comments & Advice:
  1. Valerie says:

    I am one of the two founders of my business.
    Now there are four of us; one of which is “defective” meaning that he did not keep up on his verbally agreed part of the business.
    The only thing in writing that he has, is a certificate of shares (that isn’t even under his name but under a corporation, that if I am not mistaken is dissolved)…
    We suggested he leaves, as he has already collected back his initial investement, and then some, but he refusess, hoping that he will get more…
    What can be done???

  2. It depends how the company is structured, what agreements are in place, (buy out provisions, right of first offer)and who has controlling interest.

    If you want to be really dirty you can simply dilute the ownership percentage of the company by issuing more shares to the three good owners for equitable contribution.

    There is really no nice way of getting rid of a bad partner/shareholder. It will get ugly, especially if he owns more than 10%.

    If they won’t accept a tender offer, your going to have to get creative.

    Most likely the easiest way is to dilute him out by bringing in another partner who buys in for newly issued preferred shares or something.

    This is really why I prefer the LLC vs the C-corp.

    -Mark A. Bartholomew, Managing Director
    Newport River Company

  3. Heidi says:

    I recently started a small business with a partner. After some initial startup it became clear that she really does not have time for this business and that she doesn’t have anything to bring to the table of any value for the business. She realizes this and says that I can be the sole owner, however she wants to receive 15% of the profits for the life of the business. I feel this is way too much considering we are still in the start up phases and have made minimal money to date, all of the clients and sponsors are from me and I have done most of the work.
    I would like to buy her out, but I don’t know how much that would cost. She seems to want money. Is there a way to calculate the worth of our business?
    My other option is to give up the name and start my own business alone. Which may be the best option, though I like our name. What do you think?
    Thank you,
    Heidi

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