Dealing with deadlock in the 50-50 business

Trevor Livingston, The Daily Record Newswire

Equally owned 50-50 businesses are inherently dangerous. In time, disagreements about management and the direction of the business are going to arise. Sometimes these disagreements are small, such as a decision about what office furniture to purchase or the number of employees to hire. But sometimes these decisions are big, such as decisions about how much debt the business should carry and whether the owners should consider entering into a new line of business.

What do you do when one owner says "no" and one owner says "yes," and neither owner is willing to compromise? Depending on the nature of the disagreement, if left unaddressed, the business could come to a standstill or wilt on the vine.

Usually, a one-time disagreement doesn't lead to deadlock. These disagreements tend to be resolved amicably by negotiation, open communication and compromise. More commonly, it is the prolonged failure to see eye-to-eye over routine business decisions, perceived abuses of past compromises, and the escalation of personality conflicts that build up over time and lead to deadlock.

Unfortunately, there is no easy solution for dealing with 50-50 deadlock. Even the best, most thoughtful planning at the outset will not anticipate all disagreements among owners. A true 50-50 ownership structure, by its nature, has a tendency to lead to deadlock. Here are a few tools to help deal with the deadlock dilemma:

- Turn to an outside adviser: Sometimes a neutral third party, such as former business mentor or adviser, can be enlisted to help break deadlock. Problems arise, though, if this person doesn't have sufficient knowledge about the particular business or industry, or if the person isn't equally respected by the owners or viewed as a neutral party.

- Try mediation: Professional mediation is another option, especially if the relationship between co-owners has eroded so much that effective communication is no longer possible on its own. There is never a guarantee that mediation will work, and it can be expensive and time consuming.

- Employ a "put" or "call" option: The co-owners can also agree, from the start, that one party can force the other into buying or selling its ownership interests in the event of a material disagreement. With a "put option" Owner A can force Owner B to buy out Owner A's interest. Similarly, with a "call option" Owner A can force Owner B to sell all of Owner B's ownership interests to Owner A. To discourage sales and to incentivize mutual agreement, sometimes these options come with a discount or "haircut" such that the party initiating the option is forced to sell for less than, or purchase for more than, fair market value.

However, put and call options won't avoid deadlock if both parties have the right to exercise these options at the same time. To be effective at avoiding deadlock, only one party should be given this option.

- Consider "Solomon's Choice" provisions: A "Solomon's Choice" provision is another popular method of dealing with deadlock by 50-50 owners. Pursuant to these types of provisions, either owner can make an offer to the other to buy out the other's ownership interests at a specific price. The owner receiving the offer must either accept the offer and sell at the offer price, or flip the deal and buy out the offering owner at the proposed price.

Problems arise with these provisions if the owners don't have similar financial means. The owner with better access to capital can make a low-ball offer if he or she knows the other owner is incapable of coming up with funds to flip the deal.

Despite proactive approaches and best intentions, in some cases, these tools may prove ineffective. As a last resort, the parties may decide that voluntarily dissolving and liquidating the business is the best solution, when compared to prolonged deadlock. In the liquidation process, the business will pay off all of its debt and then distribute its assets as equally as possible to the co-owners. Liquidation rarely leads to capturing full value of the business; more likely than not, it will lead to significant value being wasted by owners.

At the end of the day, the best way to avoid deadlock is to avoid equal 50-50 ownership. But sometimes that just isn't possible because two owners want to be treated as equals. In such cases, the risk of deadlock will be a concern and will need to be addressed eventually.

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Trevor A. Livingston, a shareholder with Schwabe, Williamson & Wyatt, maintains a general business practice and represents companies in a variety of commercial and corporate finance transactions. Contact him at 503-796-7452 or tlivingston@schwabe.com.

Published: Mon, Apr 18, 2016

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