Equal Ownership, Unequal Risk: Avoiding Deadlock in a 50/50 Business

A 50/50 ownership structure often seems like the fairest way for two founders to own a business. Each owner has an equal economic interest and an equal voice. But that equality can also create a significant vulnerability: when the owners disagree, neither has the voting power to move the company forward.

A disagreement over taking on debt, making a significant capital expenditure, hiring or terminating key employees, making distributions, admitting another owner, or selling the business can become more than a difference of opinion. If the company’s governing documents require both owners to approve the decision, the business itself may be unable to act.

The best time to solve that problem is not after the relationship between the owners has deteriorated. It is when the business is formed and the owners still agree on how disagreements should be handled.

1. Decide Who Decides

Equal ownership does not necessarily require equal authority over every business decision.

Two 50/50 owners can divide operational responsibility based on their respective roles. For example, one owner might have final authority over sales and business development while the other has authority over operations and personnel.

The operating agreement, shareholder agreement, or bylaws can then identify a narrower category of reserved decisions that require approval from both owners, such as admitting a new owner, incurring debt above a designated amount, making extraordinary capital expenditures, changing owner compensation, selling substantially all company assets, or dissolving the company.

This structure allows the business to function efficiently while preserving joint control over decisions that fundamentally affect the owners’ investment.

2. Establish a Deadlock Procedure

For decisions requiring unanimous approval, the governing documents should answer another question: What happens when the owners cannot agree?

One approach is a defined escalation process. The owners might first be required to meet specifically to address the disputed issue. If they remain at an impasse, the agreement could provide for a cooling-off period followed by mediation.

Mediation can be an effective means of resolving disagreements, but a mediator generally cannot impose a decision. If the owners want an outside person to actually break the tie, the agreement should expressly create a binding mechanism, such as arbitration, an independent director or manager, or another agreed-upon decision maker.

The appropriate mechanism depends heavily on the business. The person qualified to resolve a dispute over a construction company’s capital expenditures, for example, may be very different from the person suited to resolve a dispute regarding a professional-services firm’s compensation structure.

3. Plan for the Possibility That the Owners Can No Longer Work Together

Some deadlocks cannot be resolved because the real disagreement is no longer about a particular business decision. The owners simply no longer want to be in business together.

A well-drafted agreement should address that possibility too.

A buy-sell provision can establish a mechanism through which one owner purchases the other’s interest. The agreement should specify how the process is initiated, how the company will be valued, the time for responding, how the purchase will be financed, the timing of closing, and how personal guarantees and other obligations will be addressed.

Another possibility is a shotgun provision. One owner offers to purchase the other’s interest at a stated valuation, but the receiving owner has a choice: sell at that valuation or purchase the initiating owner’s interest on the same economic terms.

Although this structure gives the initiating owner an incentive to propose a reasonable price, it is not appropriate for every business. If one owner has significantly greater financial resources or access to financing, the theoretical ability of either owner to become the buyer may not produce a practically equal result.

Other businesses may prefer a sealed-bid process, an appraisal-based buyout, a private auction between the owners, or ultimately a sale of the company to a third party.

4. Do Not Rely on a Court as Your Deadlock Provision

When owners have not agreed on a way out of a deadlock, their remaining options can become expensive.

Michigan law provides judicial remedies in certain circumstances. For example, the Michigan Limited Liability Company Act authorizes substantial relief when a member establishes illegal, fraudulent, or willfully unfair and oppressive conduct, potentially including dissolution, alteration of an operating agreement, a fair-value purchase of a member’s interest, or damages. MCL 450.4515.

But being able to ask a court for relief after a business relationship has collapsed is very different from having a contractual mechanism designed to prevent that collapse in the first place.

Litigation consumes management time, costs money, creates uncertainty for employees and customers, and can diminish the value of the very business the owners are fighting over.

Plan for Disagreement While You Still Agree

No operating agreement can prevent business owners from disagreeing. A good one can prevent those disagreements from paralyzing the company.

For a 50/50-owned business, the governing documents should do more than state that each owner owns half of the company. They should answer the harder questions: Who has authority to make which decisions? Which decisions require agreement? What happens when agreement is impossible? And, if the owners can no longer work together, how does one of them exit?

Those questions are much easier, and considerably less expensive, to answer at the beginning of a business relationship than after a deadlock occurs.

Plan now, before a deadlock puts the business at risk.

The attorneys in Foster Swift’s Business and Tax Practice Group can help business owners structure operating agreements, shareholder agreements, buy-sell provisions, and other governance documents designed to address these issues before they become disputes.