People often band together to start nusinesses. They don’t always stay together. When someone wants out, or when the group decides someone has to go, one of the most important issues is how to return the leaving person’s investment while keeping the business going. Exactly how this will be accomplished will depend on whether a procedure was agreed in advance, and, if it wasn’t, how the business is legally organized.
Most small businesses with more than one owner are organized as either a partnership, a corporation, or a limited liability company (LLC). These have different rules on what to do when one of the owners leaves.
Leaving a Partnership
The easiest way to deal with a partnership breakup is to recognize at the beginning that it might happen. The partnership agreement can include a buyout price or a formula to set the price, depending on the conditions of the breakup. If the partners don’t think of this in advance, the law does have a procedure for handling buyouts, but it can get messy.
In Oregon, on leaving a partnership that decides to remain in business, a partner is entitled to be bought out at “fair value.” This does not necessarily mean the market value, but instead is the partner’s proportionate share of the overall partnership value. The leaving partner’s debts to the partnerhip and any damages that may be owned for leaving in violation of the partnerhip agreement or of some other obligation owed the partnership, are deducted from the buyout price. If the partners don’t agree on a buyout price after an announced withdrawal, the partnership should make a final offer and the leaving partner is then required to accept or sue the partnership for what he or she considers to be the fair price. This usually is an expensive lawsuit that may require both sides to hire accountants as expert witnesses or pay a court-appointed appraiser and may result in the court ordering either side to pay the other’s attorney fees. For this reason, as long as everyone acts in good faith and generally agrees on what to consider in setting the price, it’s usually a good idea to try to negotiate the price.
In Washington, when a partner leaves and the remaining partners decide to keep going, the leaving partner is entitled to his or her share of the partnership’s net value, without taking into account goodwill. Debts owed to the partnership and damages from leaving in violation of the partnership agreement or other requirements, against, are offset.
In both states, the buyout may be delayed if a term specified in the agreement for the partnership to continue has not expired, or if the partnership is in the middle of a significant business undertaking.
Leaving a Small Corporation
Corporations, in theory, are designed to be easy to get out of. All the leaving shareholder has to do is sell his or her stock. The problem is that in most small corporations, the only willing buyers will be the other shareholders, and if the breakup isn’t friendly, they may try to lowball the purchase price. There are two ways to deal with this problem.
First, the bylaws of the corporation or a shareholders’ agreement could include a sale price or a formula to set the sale price. This should be carefully considered and discussed before starting business so that everyone will be happy with the result. Once agreed to, the shareholders will have to live with it.
Second, both Oregon and Washington have followed the lead of most states and enacted “dissenters’ rights” laws, which allow shareholders who disagree with a major decision (such as a sale of the corporation or its assets) to force the corporation to buy back their shares. The board offers a purchase price, and if the dissenter disagrees and the parties do not settle on a price, the corporation is required to ask a court to set a fair value. (If the corporation doesn’t, the dissenter can sue the corporation to force its hand.) As with partnerships, a buyout lawsuit is expensive. Most of the time, serious negotiation is a better strategy.
Leaving an LLC
Once again, the easiest way to handle breakups in an LLC is to address the issue in the LLC agreement. If this isn’t done, the LLC may be left in a very difficult situation that may force a total shutdown to get rid of an unwanted former member.
In both Oregon and Washington, leaving an LLC that doesn’t address the issue in the LLC documents is difficult. A member may withdraw from the LLC, or may be expelled, but, unless the LLC documents allow for a buyout, the LLC is not required to buy out the former member and the former member is not required to accept one. Instead, the former member becomes a free rider on the LLC, and continues to accumulate a share of profits or losses. The former member is entitled to receive distributions the same as the remaining members for so long as the LLC continues to exist, and upon the final dissolution of the LLC. Obviously, this is an undesirable situation, and anyone setting up a multiple-member LLC would be wise to have a buyout clause in the LLC agreement.
In general, when setting up the business, it’s a good idea to plan ahead regardless of how the business is organized. It’s extremely unlikely that everyone will retire at the same time, and there’s no guarantee that the business will attract a buyer at a time that everyone will be willing to leave. As a result, preparing for the day when someone needs to be bought out is one of the best defenses against tearing the business apart to let someone out of it.