How to build a strong “Divorce Strategy” in an Operating Agreement

Questions that I would consider when thinking about a buy-sell agreement include:

• Background Question: Is the LLC manager managed or member managed? This will determine if some of the questions below are relevant or not.
• For what exits will a member/manager be paid and will there be a discount for different exits? Examples include:
  • Retirement receives full payment
  • Early retirement receives a pro-rated amount (e.g., 80%)
  • Voluntary departure (e.g., 50%)
• Is a member who is no longer an active participant in the company allowed to maintain ownership?
• What insurance if any will be in place in the event of a member dying or becoming incapacitated?
• Are membership interests transferable upon death or will the company buy out the member's heirs?
• How will the valuation be performed in the case of a buy out? More complex valuations are not always better if they introduce room for variance. For instance, a discounted cash flow valuation probably isn't appropriate given that different members may use very different discount rates.
  • Independent valuation
  • Factor based on last X years of either tax or books records
• Which attorneys/people will review the buy-out agreement? As a member, I would want to have the buy-out agreement reviewed by an attorney other than the company's attorney, since the company's attorney represents the company not the individual members.

In addition to all the standard shareholder agreements (buy-outs, drag-along, tag-along, death, divorce, etc), I'd ask yourself (and your partner) if one of you walked away after a year or two, three, five, etc, how much equity you would expect to retain (from both perspectives). In other words, come up with a vesting strategy.

I'd also suggest you think about what happens if one of you stops working or gets sick and can't be as productive or just isn't very productive to begin with, i.e. the other one ends up doing all the work. Despite the best intentions, personal situations can change how productive people are which isn't fair to the other person. Death and divorce is relatively easy to agree on, but dealing with a slacker is painful.

In general, talk very openly about your visions for the company, what you would like to see the future bring, what your roles will be. If any of the discussion makes you uneasy, don't just brush it off because whatever you feel now will be amplified when the situation actually occurs. Better to fight through it now when you haven't invested your time.

As suggested by the varying approaches of the preceding answers, there are many ways to address the issue that you have raised.

You may find Resolving Small-business Disputes: The 50-50 Deadlock, and the sample-language download link at the end of that post, helpful.

Disclaimer: This post does not constitute legal advice and does not establish an attorney-client relationship.

If you are entering a 50/50 deal, think about adding a Mexican Shoot Out clause (also called Texas Shoot Out).

http://www.mediate.com/articles/spoelstra6.cfm

All interesting and useful answers that will help you build a strong foundation for legal action, if necessary. Thing is, you don't want to get there because it's costly and butt ugly.

Love your analogy to marriage. Create a Owners Charter that includes language around communication (i.e. the best way to: email, text, in person meetings; when, why, on what topics?) and dispute resolution (i.e. mediation or arbitration clause; when to elevate; what topics are negotiable) to delay or possibly avoid a workplace divorce.

Sadly, I've worked with startups who initially poo-pooed having a Charter but later struggled with talking through highly charged emotions when the business grew rapidly or someone lost interest. The losses financially and emotionally were harsh. Don't be that startup.

Your local mediation center can help you draft language, and even mediate, should the need arise. Good luck!