Shareholder Divorce: How To Split From Your Business Partner

This is the eighth in a series of brief articles that Moye White is sending to its clients and friends to provide practical advice about the opportunities and challenges presented by today's economy.

A downturn in the economy doesn’t just affect a business’ bottom line, it can often create tension between business partners or exasperate existing differences. Challenging economic times coupled with strained relations with one’s business partner, find some contemplating a split from their business partner. Whether or not faced with this today, you should always be prepared and understand how best to protect your interests should you or your partner decide it is time for a “corporate divorce.” The key is proper planning when the relationship is good.

  1. Significant Disputes Commonly Arise. When starting a new business or business relationship, deciding how to leave the business is usually far from one’s mind and often given little thought. Nevertheless, as a business becomes more established it is quite common for partners to find themselves facing significant disputes with their partner during both good times and bad, as depicted by three common scenarios below:
    • Thriving Business. When a business is doing well, disputes often arise regarding the relative workloads or value of contributions to the business, leading to disagreements about compensation levels or ownership percentages.
    • New Direction. Partners may desire to take the business in different directions, no longer sharing the same vision for its future.
    • Tough Times. When a business is failing or facing troubled circumstances, partners may each blame the other for its problems, fighting over who should have rights to what little remains.
  2. Review Shareholder and Other Governance Agreements. In considering whether to split from your business partner, look first to the terms of the business’ governance documents, including shareholder agreements, buy/sell agreements and the organization’s governing documents (articles, bylaws, operating agreements, etc.). Ideally, a business should clearly lay out within such documents, the terms, conditions and procedures for the buying and selling of company interests, as well as the manner and/or methodology by which the business may be sold or dissolved from its inception. It is most cost effective to consult a lawyer during your business’ formation stage and develop an agreeable, and if possible, objective exit strategy to save you much time, money and heartache should you or your partner decide to leave in the future.
  3. Consider All Options. If you and/or your partner decide not to continue on together with the business and your business’ governance documents do not provide the necessary guidance regarding an exit strategy, then consider all options available to you including:
    • Maintain Relations. Keep the business relationship in tact while making any needed, equitable adjustments. For example, if compensation levels or ownership percentages no longer reflect the actual division of work or share of responsibilities, suggest a review and equitable restructuring of these. Be creative and also ready to provide records demonstrating the amount of work and/or value you contribute to the business. Be willing to hire and rely on outside consultants.
    • Buyout. If you desire to continue on with the business without your partner, then offer to purchase his or her company interests or find a potential buyer whom you would like involved in the business and who can make such an offer. If the shareholders agreement or other governing documents do not provide for a price or valuation methodology for the company interests, and no agreement can be reached regarding such price, then start by agreeing to a valuation methodology for determining the sales price. You may want to rely on the valuation as determined by a mutually acceptable independent party. If company interests are offered to a third party, make sure any applicable “right of first refusal” provisions are complied with. Such provisions give existing partners first priority in accepting or refusing sales of company interests.
    • Business Sale or Dissolution. When disputes between partners cannot be resolved so as to continue a viable business, a sale or dissolution of the business may be the only remaining option. If it is agreed that the business should be sold or dissolved, it will be essential that the distribution of any proceeds or division of company assets be conducted properly. The last thing partners will want to or should have to deal with are claims brought against them as a result of improper distribution or dissolution. To help protect against such claims, review the business governance agreement provisions for any and all business sale or dissolution-related provisions. Additional legal requirements may also exist and you should consult a lawyer to help guide you though any statutory or other required dissolution procedures.
      • Parties who decide to sell or dissolve their business due to conflicting differences, may find using a third party particularly helpful in assuring that such process is properly and smoothly conducted. It is important for partners to maintain good communication, directly or through a third party, throughout the sale or dissolution process. Remember that despite differences, partners continue to share the common goal of preserving the value of their business. Regardless of whether the business is being sold or dissolved, make every effort to avoid personal disputes from diminishing the value of what you have worked so hard to achieve.

As with any significant business change, consulting a lawyer will help to protect and promote your interests, making sure you have fully complied with all contractual and other legal requirements to which you may be bound.

For more information contact: John W. Kellogg or Terri L. Rithner at (303) 292-2900.

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Moye White LLP has prepared this bulletin to provide general information, however this bulletin does not provide legal advice and does not create an attorney-client relationship between the reader and Moye White. No legal or business decision should be based solely on the content of this bulletin.