Exit Planning for Business Partnerships

Before going into business, potential partners should take the time to plan for an eventual exit. Even if operations are already underway, exit planning is still vital.

Exit planning means that business partners have a clear strategy or process to follow if their working relationship later sours or if one partner chooses to leave the business or retire. A well-crafted exit plan can avoid disputes or confusion if a business partnership terminates for one reason or another. Below are some common structures that business partners often use as part of an exit plan.

If you and your partner or partners need help evaluating your options in exit planning and developing a plan that works best for your business, contact Farley Law today for a confidential consultation. Our legal team will be ready to discuss your options and what we can do to assist you with the exit planning process for your business.

Option to Purchase, Option to Sell

One common feature of business partnership exit plans includes options to purchase/options to sell. These options are typically used when one business partner wishes to exit the business, usually due to retirement or a loss of interest in continuing to work on the business.

Business partnerships may not want to have “dead equity” belonging to a retired or departed partner. They also may not want partners who leave the business to sell their interest to a third party. Options to purchase/sell allow partners to voluntarily leave the business while also cashing out their interest in the business and seeing the benefit of their hard work.

Buy-Sell Clauses

Buy-sell clauses usually refer to provisions of partnership agreement that require a partner to sell their interest to their other partner or partners in the event of an unresolvable dispute among the partners. Buy-sell clauses may have an objective valuation method for a partner’s interest or may have a “shotgun” provision that allows who received the buyout offer to instead turn around and demand the offering partner’s interest on identical terms (which can help prevent low offers).

Buy-sell clauses should also have long notice periods to prevent surprise, as well as lookback provisions to allow the bought-out partner to share in the sale of the business if it is acquired soon after the buyout.

Right of First Refusal

Right of first refusal clauses are often used in partner agreements to help prevent a partner from selling or otherwise transferring their ownership interest to a third party. With a right of first refusal, the other partner or partners in the business can acquire the exiting partner’s interest on the same terms that the exiting partner negotiated with a third party.

LLC/Corporation Existence for Term or Until Stated Purpose Is Achieved

If partners intend for a business to operate for a specific time period or to achieve a specific goal or purpose, partners can include appropriate provisions in the business’s partnership or operating agreement or corporate bylaws to require the termination or winddown of the business once the agreed-upon term expires or the business achieves its purpose.

Drag-Along Rights

Drag-along rights refer to provisions in a partnership, operating, or shareholder agreement that allow the owners of the majority interest in a business to require minority owners to join in with the sale of the business.

When the sale of a business makes good financial sense, business partners may not want a potential deal to be scuttled by one partner refusing to sell their interest if an acquiring party is looking to buy the business outright. Under drag-along rights, the majority owner or owners must ensure that the minority owner or owners sell on the same price, terms, conditions that the majority has received.

Tag-Along Rights

Tag-along rights refer to the right of a minority owner to join in on a majority owner’s sale of their interest in the business to a third party. This differs from drag-along rights, which involve a majority owner forcing a minority owner to join in on a sale, as tag-along rights instead allow a minority owner to force a majority owner to include them in on a sale of the business.

Tag-along rights often require majority owners to include minority owners in on sale negotiations so that the minority’s interests are considered. Minority owners then get to sell on the same terms as the majority.

Company-Owned Life Insurance

If a partner’s ownership interest needs to be cashed out following their death or disability, the business may not have the financial resources to cover the cost of the partner’s interest. Businesses can take out a company-owned life insurance policy on the lives of the business partners, which pays a benefit to the company upon the death or permanent disability of a partner.

Divorce/Death/Incapacity Buy-Outs

The death, disability, or divorce of a partner can have serious financial and operational consequences for a business. To avoid these consequences, many partnership agreements include clauses that require a partner or their estate to have the partner’s interest in the business bought out in the event of the partner’s death, permanent disability or incapacity, or divorce. This prevents a situation where ownership interests end up getting passed to a partner’s ex-spouse or heirs.

Necessity for Planning Up Front

No one enters a business partnership thinking about when the partnership may end or fail. However, partners’ business relationships will eventually come to an end, either when one of the partners retires or passes away, or if the business fails, or if the partners’ professional relationship changes.

Whether a business partnership ends because the partners have become antagonistic towards one another or because a partner retires, becomes disabled, or passes away, partners should have engaged in exit planning long before the partnership ends.

Upfront planning can make the exit process a lot smoother. If partners’ relationship has broken down, personal animosity can lead to significant disputes. Or if one partner’s interest needs to be cashed out, the remaining partners may have difficulty keeping the business going while trying to pay the exiting partner for their interest in the business.

It is never too late to start putting together an exit plan even if partners have already started their business.

Farley Law, PLLC helps business owners identify business and legal strategies they can use to protect their business and personal assets. If used correctly, proactive legal strategies can help business owners, increase and keep more of their income, avoid losses, and increase peace of mind regarding their business dealings. Have a question or a comment? Send us a note at business@farleylawpllc.com