As in actual marriages, business marriages do not always work out, and the result can be just as nasty. This is especially the case for small, closely held businesses, which are often times formed by people with a close relationship.
It is natural to form an emotional bond with the business you have created. Of course, there are financial implications that go along with it. For small, closely held businesses, proper planning is the best practice to minimize any disputes, but even that carries with it issues.
Typically, when small groups of people (generally, two to four) form a business, no one in the group wants to have less control than the other(s). This is understandable, but carries with it the potential of deadlock in the event the owners want to go in different directions. Ideally, the owners will have addressed this concern via a shareholders’ agreement or operating agreement.
Different options to address deadlock expediently include allowing an agreed upon third party, such as a trusted adviser or attorney, to settle the tie-breaker (or even to do a coin flip, as silly as that may seem). Beyond that, the main options to include in an agreement are mediation, arbitration and litigation. If no such agreement exists, the default remedy would be litigation – the costliest and most time consuming of all.
Mediation is a relatively inexpensive process that allows the parties to meet with a neutral mediator in a non-threatening environment. The pre-mediation preparation can be extremely valuable for the client to understand the strengths and weaknesses of their position. The drawback to mediation is its non-binding nature. Therefore, it can be a waste of time if both parties do not go through the process having a true intent of resolution.
Many people believe that arbitration, essentially a more formal and binding form of mediation, is the best remedy.
In general, it is far less costly than litigation because the process is quicker and generally less complicated than a court proceeding. It also is more flexible in terms of timing, as arbitrators are more likely than judges to cater their schedules around the needs of those involved. There are downsides, including limited recourse if a party believes the arbitrator’s decision is unfair or illogical.
If neither mediation nor arbitration is agreed to by the parties, either via a pre-existing document or at the time of dispute, then litigation becomes the only option.
One necessary step, whether through settlement or court verdict, is valuing the business. Valuing a closely held business is no easy task. Certain industries might have rules of thumb (for example, a multiple of EBITDA), but the unique characteristics of each business often make those rules unreliable.
A full-blown appraisal, however, can be expensive and time-consuming. Instead, it is often advisable to opt for a “quick and dirty” valuation, known as a calculation engagement, which entails relaxed development and reporting requirements. It is, therefore, less expensive.
One final approach is to employ a “shotgun mechanism,” where one owner is required to name a price, and the other owner is then required to choose to either buy or sell at that named price.
Just like in marriages, the best intended business relationships often can end in a War of the Roses. Business owners are well advised to put in place mechanisms to avoid that situation, either through deadlock provisions intended to help with decision making or provisions detailing a method for a parting of ways if that is the best alternative for the parties.
• Ryan Farrell is a certified public accountant with Zukowski, Rogers, Flood & McArdle in Crystal Lake. Reach him at 815-459-2050