Looking
for the Exit
"I’m taking on a business partner," proclaimed the entrepreneur on the other end of the phone call. "This is a marriage made in heaven!"
Even though I felt I was throwing cold water on his enthusiasm, I peppered him with questions. I asked "George" (not his real name), "Have you worked out a letter of intent and outlined the important business points? Do you know the amount of capital your partner is bringing in and the percentage of equity that will be allocated for it? What is your exact timetable?"
"No, not yet, we figure we will work that out in the next few months. But we both agree this is a great opportunity for a partnership," he replied.
"What if a year or two down the road, things aren’t working out well? What if there are hard times and the two of you fail to agree on an appropriate course of action? Has your memory of what happened a few years ago faded so quickly?"
Silence on the other end of the phone. Like a child in a bad divorce, George had had a front row seat years earlier when a major disagreement among the parties at his former employer left the organization in a shambles. After a couple of years of struggling to regain its focus and momentum, the company was forced to close down.
George had decided to set up his own facility following the closing and was able to make a go of it with minimal capital and maximum effort and sweat. Now he wanted to add a partner to his thriving business.
A cold shiver was probably traveling up and down his spine as the events of those times came hurtling back to him. Although I had only been a bystander at the time, my recollections were crystal clear. His head had to be swimming.
Too often, in an effort to move projects, partnerships, financing, and other arrangements forward, we have a tendency not to look for the exit, and fail to provide for contingencies in case something does not work out right. We have all been there at one time or another.
It doesn’t have to be a disagreement that causes changes within an organization. Other issues to be considered include what to do in the event of the death or incapacity of one of the parties.
It usually takes only one mistake for us to realize how to avoid a particular problem the next time. Sometimes though, the cost of that mistake can preclude there being a next time. Taking some basic precautions today can help us to avoid, or at least minimize, the problem, and thus avoid unpleasant legal actions.
Even in situations that might seem to call only for a "handshake" agreement, it is important to document the understanding in the form of a written exit agreement, drafted professionally by the parties’ respective legal, business, and tax advisors. Generally speaking, it is best to do this today, while everyone is still on friendly terms. If things ever get to the point where an exit agreement is needed, it will be too late: it will probably not be possible to resolve the situation outside a courtroom.
Consider the following points when having discussions with your potential business partners, then structure the agreement to incorporate the results:
- Determine the specific circumstances or actions on either party’s part that would be cause for invoking the agreement.
- Determine the circumstances separately for the various factors that may arise in the future.
- In the event of a buyout of an equity interest, determine whether the firm, a specific partner, or an independent third party can buy out the other partner’s shares.
- Draw up the formula to be used in calculating the worth of the total entity at the buyout date so that you will be able to determine each partners’ portion of that total.
- Specify the period over which the departing partner’s share is to be paid out, including whether interest (at a pre-specified rate or by a formula) should be a part of the payment.
- Decide if the payout calculation is subject to audit/review by a qualified CPA and who would pay for that service.
- Analyze what impact, if any, there will be on the other partners in the event of a change in control of the company and how the change in control will be defined.
- In case of a dispute over the contract terms and their application, include a clause stating whether mediation, arbitration, or other means will be used to resolve the differences.
The partnership agreement should include specific definitions as to how various other business matters are to be handled, not just exit agreements. It is also important to recognize that exit agreements or contingency planning should apply to executive contracts, vendor agreements related to future payments and non-performance, as well as a host of other business arrangements that arise in everyday situations.
I helped George develop his contingency plans, and think that he now feels more secure about his future with his new partner.
Although it is not possible to list here all of the possible scenarios that could arise, planning now can avoid problems later. In business, just as when we board an airplane or enter a crowded theater, it is important to look for the exit, just in case.
