Business Owners Separation – One Solution

“They say that breaking up is hard to do

Now, I know, I know that it’s true

Don’t say that this is the end Instead of breaking up

I wish that we were making up again”

Lyrics from the 1975 hit Breakin’ Up Is Hard to Do by Neil Sedaka

Let’s face it, whether it is a business or a personal relationship, breakups are tough.  There is usually some underlying issue or problem that could probably be addressed logically, but soon emotions take over which leads to the famed “irreconcilable differences” and before you know it, you need an intermediary; sometimes to avoid physical confrontation.

I have been involved in countless shareholder disputes; many rather benign, but, also, a few doozies.  Trust me, I am not a lawyer and when the legal threats start getting tossed back and forth, I am one of the first to head for the exits.  I am not so naïve to believe I can reconcile irreconcilable differences; it’s just not what I do.

But, many situations can be negotiated out as long as there is some desire to reach closure by both parties.  I have watched a very good lawyer friend of mine do this many times under the guise that many differences can be reduced to dollars and cents.  Quite honestly, an objective issue (like money) is much easier to negotiate than a subjective one (like hurt feelings.)

Here is one technique that I recently used that seemed to work following this concept. Three partners in a business decided to go their separate ways.  Of course, there was no provision in the “shareholders agreement” to cover this eventuality.  Though often used as a solution, selling the business was not an option here.  There were also differences as to what each wanted to do in the future.  With all of the focus on each owners’ share of the company, there seemed to be a logjam in the separation process and it started to negatively impact the business.

I decided to bifurcate the focus into compensation for value contributed and ownership rights.  After consulting with a compensation consultant, we were able to get the parties to agree to compensation levels based upon job responsibilities and then two owners agreed to take less compensation for less time.  Next, we followed the concept of owners getting paid for any share of the business they gave up.  We set up some limited buyouts and after a few weeks of haggling, an overall solution was reached.

With hindsight, there was really no major dispute.  It was simply that a couple of owners wanted to pull back a bit but unfortunately, there was no framework to do so.  Once emotions were put aside, getting to a solution was not that difficult.

So, two simple lessons learned.  First, keeping a focus on measurable versus subjective points helps when resolving ownerships issues.  Second, and more important, the time to negotiate exit provisions is at the beginning of a relationship, not in the heat of a dispute.  Keep in mind the old adage… you should not get into a deal unless you know how you are going to get out.

Myths About Startup Equity

“Mr. Fuji as everyone knows, is a fountain of misinformation.” Quote from the late great Gorilla Monsoon a star from the World Wrestling Federation.

Here in the New York Metro area, we get the chance to hold sessions with loads of startup companies.  From incubators to accelerators to coworking spaces, we get the opportunity to meet with some of the best and brightest minds especially in the tech space. Their ability to question everything and absorb a multitude of ideas and observations is second to none and a unique skillset that many of us admire.

We are accountants and consultants and so topics we present tend to center around accounting and taxes. While I would love to think those attending are mesmerized by our subject matter, I have come to believe it is the free pizza and soft drinks which attract them. However, there is a subject we cover that seems to draw a bit more of a response than the equivalent of sitting through a root canal – – and that subject is equity. How to split up the pie; techniques to use to share ownership and pitfalls to avoid seem to get attendees to perk up. Like most things in life, when deciding on equity sharing, a bit of advanced planning helps; but who has the time when one is creating their MVP, trying to drive the community to their product or preparing for a Demo Day.

Unfortunately, we have heard a few myths over the last couple of months and I thought it best to take some time to clear the air a bit.

  1. “You can wait to issue equity” – actually when you issue equity is completely up to you; the value you have the use in the transaction is the issue. Just keep in mind assuming the value of your entity increases over time (or else why would you give up your life for it) the higher the value, the more difficult this task becomes.
  2. “Founders can always get shares at discounted rates” – one of the better tales we have heard. Founders’ shares only have minimal value before you raise financing and there is no near term proof of value (usually by some outside party.) However, once funds are raised, you may get more shares as a founder but the new (and usually higher) value has to be taken into account.
  3. “We don’t need no stinkin’ valuations” – unless you are in a clear founders’ shares startup situation or use the value of a recent transaction, yes you do need a valuation (referred to as a 409a as this is the IRS regulation that governs.) Without it, your tax exposure can make you the next Leona Helmsley.
  4. “I can always file an 83b” – as long as it is filed within 30 days of receiving the equity, it uses an appropriate value and you pay any related tax, yes you can. After that, you can’t put that genie back in the bottle and you are on your own.
  5. “Who cares if my company is an LLC or C Corporation?” Almost every investor does; and most prefer C Corporations.

Equity issues are complex and costly so please consult with your attorney and accountant before completing any equity transactions. Relying on a myth can cost you dearly.