What is a Business Separation Agreement?
A business separation agreement is a legally binding contract designed to sever the business interests of the stakeholders involved. It’s often the strategy of choice when one or more stakeholders no longer wishes to participate in the managing or ownership of a business, and the parties are prepared to negotiate the price, terms, rights , responsibilities and obligations attached to the exit of one or more stakeholders. Having a properly drafted business separation agreement is critical to insuring the successful outcome to an individual’s exit from a business.
There are numerous reasons why one or more stakeholders could separate from a business, such as disagreement over the management of a business, irreconcilable disputes, changes in business direction or strategy, life events such as retirement, incapacity or death, or other circumstances affecting the viability of the business.
Key Components of a Business Separation Agreement
The key elements of any separation agreement between business partners include the division of assets and liabilities as well as any payment or distribution of money to one or more business partners. If a partner is forced out or is leaving the company voluntarily, the remaining partner(s) may be required to compensate the former partner some value for the business. Since many business partners have put much of their own money into the company, they often are unwilling to part with their assets. Thus, it is important to clearly define who gets what in the event that a business partner leaves voluntarily or involuntarily. Another important factor in a separation agreement is whether the business partner moving on has signed a non-compete. The court will review the non-compete, both in terms of geographical and material applicability, to determine whether such an agreement is valid and should be strictly enforced. The separation agreement may also contain a clause stating that the remaining partner(s) shall not compete with the business. If competition is allowed, there are parameters to be considered and defined regarding protection of intellectual property. For instance, if the intellectual property is patented, the separation agreement will outline how the patents owned by the company can still be utilized, either by the departing or remaining partner(s). Further aspects of a separation agreement also should include recognition of the respective partner(s) contributions, any agreements regarding restricted shareholder ownership, payments for goodwill and dividends (if applicable).
Legal Advantages of a Business Separation Agreement
The legal benefits of a business separation agreement extend well beyond the parties to the agreement; not only does the separation agreement provide a layer of protection for the owners, it can protect the corporation from future disputes. Specifically, a separation agreement can designate in advance who owns what company property, what responsibilities the owners have, how the liabilities of the company will be settled and what will happen if any issues arise after the separation.
What responsibilities do shareholders have? A separation agreement can set out the obligations that shareholders have to the corporation and to the other shareholders after they are no longer active owners. It can provide that the resignation of one or all shareholders does not relieve them of any obligations to the corporation, or to the remaining shareholders. This protects the corporation from the actions of former or resigned shareholders who engage in competitive activities or who disclose information they obtained while officers and directors of the corporation.
A separation agreement can also be tailored to ensure the continuing obligations of former shareholders do not go too far. For example, the restrictions on the former shareholder should not prevent that person from carrying on his or her business activities. For example, in the case of a dental corporation, a former shareholder who resigns should be free to set up a competing practice, without being forced to wait the balance of a restraint period at the former corporation.
When shareholders separate, it is important to set out the processes for dealing with ongoing issues between the shareholders. Shareholders should consider including provisions that address voting and appointment procedures if there is an imbalance created by certain owners no longer being active in the business. In the case of a partnership agreement, voting and appointment provisions should take into account the ability of the continuing owners to make appointments and carry out the business of the partnership without the agreement of separated owners. Allowing an imbalance to form, if not dealt with, can lead to a situation where the non-contributing owners are not properly represented.
Often when a number of shareholders jointly own a corporation, in addition to being a shareholder, they are also the officers and directors of the business. This can make for a messy separation if provisions ensuring that the remaining shareholders can appoint new officers and directors and remove the old ones are not included in a separation agreement. Without such provisions, the old officers and directors remain in those roles and have the ability to carry on the business as if nothing has changed. In a situation where a shareholder is removed from the business, the remaining owners should be able to ensure that their business interests are protected.
An important benefit of the separation agreement is the degree of certainty and clarity that it can provide both for the members of the corporation and any third parties who are affected by the business separation.
How to Write a Business Separation Agreement
Steps to Drafting an Effective Business Separation Agreement When a Parting or Dissolution Arises as a Result of Poor Interpersonal Relationships, Differing Business Visions and/or Objectives
No relationship is infallible. Partners may not have the same views on how to run a business nor will they always have the same interests and visions. However, when decision outcomes are consistently not in line with a partner’s objective, one of the partners may be forced to separate or leave the existing business structure, which could be an LLC, a partnership, a corporation or some other vehicle. Sometimes this separation is amicable and free of financial issues but often it is not. As a result, it is important to follow some basic steps when partitioning a business entity so that the parties can part ways fairly.
The first step for separating a business is to negotiate the terms for the separation between the owners. Generally, an agreement should stipulate how the business assets will be divided or sold and how any business debts will be paid. In addition, indemnities should be considered in case the taxes were not properly adjusted, and the parties may also choose to consider how the tax consequences will be handled.
Every business is different, and thus it is essential that the agreement consider all potential issues that may arise during a particular separation. Other considerations include whether there will be any post-separation or transitional support provided to the business or its owners, and how intellectual property rights will be handled.
It is crucial to note that the separation process itself may be lengthy, and many parties may wish to shorten this timeline using mediation or other streamlined processes. However, it is always important to at least consult with an attorney to ensure that many of these suggested issues are addressed. It is typically not advisable to move forward with a separation without advising legal counsel.
Common Business Separations Pitfalls
When Co-Owners Can’t Agree on Separation
Many times, owners of a closely held business who have been partners for many years find that they are no longer able to work together. For example, a successful couple that has spent years growing their business finds that one or both are ready to retire, but it is too difficult to separate the operation of the business and all of its customers, assets and liabilities.
In this case, the owners must either decide to sell the business or try to continue as a going concern without each other. If the parties cannot agree on how to go forward or how to value the business assets, a court can order a buyout and determine the fair market value of the business. Shareholder oppression claims may also be considered where an owner possesses a minority interest in a corporate entity and the majority owner refuses to honor that owner’s transmission request or otherwise withholds financial information, dividends and other distributions to which the minority owner would otherwise be entitled.
Even where the parties agree on "value" they may be unable to agree on just how to go about dividing up the assets of a business and compensating the respective owners. Regardless of whether a dispute can be resolved through buy-out or otherwise, it is difficult to determine what path is the best to follow. Ultimately, small closely held businesses must be evaluated on their ability to generate income for its owners, but determining value is a judgment call that varies between businesses. Corporate separation can be particularly complicated when there is a controlling owner and a minority owner. In these cases, a business owner may be able to redeem the "minority owner" out of the company .
In order to avoid disputes and potential litigation, it is important for closely held business owners to agree on a process for business separation in advance by having a buy-sell agreement or, at a minimum, a list of rules of engagement for operating in the future. For example, unless otherwise noted in an independent operating agreement, it may be difficult for one owner to prevent the other owner from engaging in business competing with or at odds with the company. This can result in damage to the business if the owner is thereafter able to recruit key employees and take customers with them.
When the Reason for Separation is Discontent
Even for businesses that continue to operate through a buy-out or otherwise, the process for separating owners can be a difficult one. Relationship breakdowns that may have been ignored through the years often end with a separation that brings out the worst in the remaining business partners. Long-standing partnerships that have grown resentful may struggle with the division of assets and could battle over huge amounts of business value. Amicable separation is sometimes not possible and may result in a bitter breakup and lawsuits that cost the company tens if not hundreds of thousands of dollars.
For this reason, it is important to get the help of experienced and objective professionals at an early stage of a dispute. Attorneys who focus on business and family law can help business owners examine their options, whether it is a negotiated buy-out, a forced divorce or business divorce, or simply a neutral assessment of the fair value of a business given its current operational structure.
While proper planning can prevent many disputes, it is almost impossible to predict the future. Having a trusted advisor will guarantee that you get the real story and not just the one you want to hear.
Lessons from Past Business Separations
One company that has handled separation agreements well is a regional chain of health clubs planning to sell off some of its non-core locations to a competitor. The health club owner recognized that when it finds a suitable buyer for the non-core properties, it will need to be "buyer-ready." That included developing an outline of the documents that would be used in such a transaction and forming a committee to oversee the separation of the business in as efficient a manner as possible. The committee hired an outside consultant to assist them in identifying and resolving critical pre-sale issues. A major emphasis of the work completed was an assessment of the company’s current program policies and compensation structures, with particular focus on any programs for which service period credits would be broken by a sale. The committee also identified and cataloged the multiple software platforms that captured member and employee data. "Life after a sale will be better for our members and our staff," according to the health club owner. "We’ll no longer have to try to be everything to everyone in so many different places. Now we can concentrate on growing the parts of our business that will still be ours and that will remain unique."
A recent example of a successful separation is an apparel retailer with several hundred locations that announced in late 2018 the splitting of its largest, most successful business into two separate public companies. The management of the retailers estimate that the two new, separate businesses will generate more than $2 billion of revenue each, with corporate tax savings estimated at approximately $50 million. Post-separation, the less lucrative business will continue to operate its department stores under the brand name it currently uses, while the more lucrative business will rebrand itself with new identities for all its department stores and concessions. In preparation for the separation, the retailers have filed initial registration statements and conducted diligence on internal controls over financial reporting, proposing to debut the new business in December 2018.
When to Get Legal Assistance
There are certain circumstances where you simply should not attempt to deal with this issue by yourself without the assistance and advice of a professional. When you have a business that is owned by shareholders, and there are extensive rights and obligations of the shareholders outlined in a shareholder agreement, you really should try to comply with those agreements. There’s no question that it is because the parties somehow did not adhere to the terms and conditions in their original agreement that they now find themselves in the position of wanting to negotiate a business separation agreement.
In these types of situations, you want to deal with a professional who has some experience dealing with the winding up of shareholder relationships . You also want to deal with somebody who has been exposed to and understands the business that you are involved in. It may be desirable to have your lawyer meet with your accountant and your financial advisor before engaging into this process so that you can understand the legal, tax, and financial ramifications of any separation of your business.
This is not a do-it-yourself job. I want to emphasize that. If you and your business partner are at a point where you are able to sit down together and get on the same page so that you can draft a business separation agreement, that is clearly the most cost-effective way to go. But, if you cannot get on the same page without third party involvement, you need to try to get yourself some experienced professionals who can help you work out the details of your business separation.