No matter whether you are a limited partner, a member of a limited liability company, or a shareholder in a small corporation, breaking up is hard to do. When it comes time to split from your soon-to-be ex-business partners, however, the following are a few of the things you need to know.
1. The property and assets of limited liability businesses do not belong to the owners of that business.
This is a surprisingly difficult concept for most of my clients to wrap their minds around, although their confusion is somewhat understandable. After all, many small business owners gave the business its property in the first place. So when it comes time to split everything up, why shouldn’t they just take their stuff back?
Well, in short, because their “the stuff” no longer belongs to them¾especially if that business is organized as a limited partnership, limited liability company, or corporation. The idea is, if the business is organized so that it provides liability protection for its owner, the law actually treats that business as a separate legal person with rights and powers all its own.
To become an owner/member/limited partner/shareholder of that business, each owner must then give something of value in exchange for his or her interest. That value given in exchange may be tangible property like cash, tools, equipment or furniture, or equally valuable though intangible property such as know-how, expertise, business contacts or services.
The property contributed by each owner now belongs, not to the owner but, instead, to the business. For the value of his or her contribution, the owner receives the ownership interest or share in the entire business and all its assets from all owners, indivisibly.
The answer is further complicated when the business has creditors. But the concept to remember is that to become an owner of the company was a process and terminating your ownership interest is too. Leaving your business, therefore, is never as simple as taking back your original stuff and going home.
2. Owners are only entitled to any assets that remain after all creditors are repaid, less liquidation expenses, and then, only in their proportionate share.
Like any other business decision, before engaging your co-owner in a business divorce, an estimation of the ultimate recovery should be undertaken. Some clients look at the revenue of the going concern or the total amount in the business’ bank account plus its assets and assume their share will simply be a proportion of that.
Two points to consider, however, are that (1) when co-owners are fighting over a business, revenue inevitably plummets in direct proportion to employee morale and inversely proportionate with each owner’s hatred of the other; (2) in liquidation, creditors are always repaid before owners; and (3) the fire sale value of “whatever is left” after paying legal, accounting, and other liquidation expenses, is what the owners then divide based on their percentage ownership or value of their shares.
Sometimes the amount owners actually walk away with may be shockingly little.
3. Self-help doesn’t help.
The cold reality that the exiting owner will not get even as much out of the business as they originally invested may lead some of them to attempt drastic and often illegal actions. Some of those actions may include emptying company bank accounts, loading business inventory into the back of their pick-up by dark of night, changing the locks, etc., to get “their” share before the others take or to simply push other co-owners out.
More subtle yet equally silly actions some owners may take include holding meetings without the now-hated co-owner, preventing the co-owner from seeing the books or otherwise knowing what’s going on in the business, firing the co-owner and convincing him he thereby has lost his ownership interest, or even starting a competing business and recruiting employees and clients from the co-owned business.
These methods backfire, however, when the excluded co-owner or the business’ creditors hire someone like me to straighten things out, and the judge makes frowny faces at the misbehaving owner from the bench.
4. If the business’ organizing agreements don’t address an issue, a court will “fill-in” necessary provisions using statutes and even case law decisions.
When co-owners fight, many of them are dismayed to learn that the original operating or partnership agreement or bylaws they thought controlled the relationship either doesn’t exist or was never signed. In the event there is no written agreement, sometimes the law actually allows oral agreements to control the terms of the co-owners’ relationship.
Alternatively, when there is absolutely no agreement or when the agreement doesn’t address a certain issue, the statutes of the business’ jurisdiction may provide default terms that fill-in terms of the relationship between the owners. Failing that, there also may be case law that explains how an issue should be handled. When there is nothing else to do, the owners must appeal to the courts to do what it deems best.
PRO-TIP: it is far better to make sure your organizing documents are in order when you form the business and certainly before you pick a business fight.
5. Owners cannot represent their company or corporation in court unless they are also licensed attorneys.
Confusion on this issue seems to arise because, though limited liability businesses and their owners are different people before the law, owners can and do sign documents and take other actions on behalf of their business. Further, everyone knows they have the right to represent themselves in court without counsel. Based on these two points, many owners therefore conclude they can argue for their businesses before the court.
While it is true that anyone can represent themselves in court , you and your business are not one person (as discussed in point #1) . Therefore, if you are not a lawyer, you cannot represent your own company in litigation.