Our previous posts have stressed the critical importance of buy-sell agreements for both majority owners and minority investors in private companies (Read here). For majority owners, securing a buy-sell agreement avoids the potential of becoming “stuck” in business with a difficult co-owner without the ability to force
The fact of the matter is that co-founders spend most of their time fighting . . . But no one talks about it. Los Angeles venture capitalist Mark Suster. (Fighting Co-Founders Doom Startups)
Setting up a private company on a 50-50 owned basis is typically a bad idea, but many founders of new businesses continue to embrace this perilous ownership structure. We wrote last year about problems that plague 50-50 owned businesses (The Potential Pitfalls of a 50% Ownership Stake in a Privately-Held Company), and a google search on the topic produces articles such as: “50/50 Partnerships; Never a Good Idea,” and “Why You Shouldn’t Enter into a 50-50 Partnership.” Venture capitalist Mark Suster explained in a column called the The Co-Founder Mythology that most people form 50/50 partnerships, “because they’re afraid to to start alone.” Mr. Suster advises entrepreneurs to “take the leap” in starting their new company, but to do so without entering into a 50-50 ownership with a co-founder. Mr. Suster states: “. . . I meet far more people who had problems with [their current partner-ship] than founders who didn’t have problems. People just don’t talk about it publicly or in blogs.” (The Co-Founder Mythology)
50-50 Owned Businesses – High Risk for Failure
The evidence backs up Mr. Suster’s negative views regarding the problems with 50-50 owned businesses. In 2013, Noam Wasserman, a Harvard Business School professor, published The Founder’s Dilemmas after studying 10,000 different business founders. According to Prof. Wasserman’s book, 65% of high-potential startup companies fail as a result of conflict among the co-founders. Pairs and groups bring a variety of skills, but there is also more potential for conflict—over the company’s leadership, finances, strategy, credit and blame. (Fighting Co-Founders Doom Startups)…
As we noted in a previous post (Read Here), the disruption and dysfunction caused by a bad business partner who holds a substantial minority stake in the company can lead to the ultimate failure of the business. This is especially true when the company founder has no buy-sell agreement in place that will allow him/her to redeem the minority investor’s interest in the company. When the majority owner has no contract right to force the minority investor to exit the business, the owner’s options are essentially limited to: (i) going out of business and dissolving the company, (ii) selling the business to a third party (iii) or selling the majority owner’s interest to another party who will step into the owner’s shoes and take on the task of dealing with the minority investor.
None of these “end the business” options are likely to satisfy a company founder who worked very hard to bring the company to life. This post therefore considers options for the majority owner of the company to consider when no buy-sell agreement exists with the minority investor who has become a major stumbling block in the path to the company’s continued success.
Setting the Stage for the Exit of the Bad Business Partner
The bad business partner may believe that he/she has the upper hand in negotiations with the majority owner. Specifically, at the same time the minority investor is wreaking havoc at the company, the investor is refusing to be bought out or is demanding a grossly inflated price for the purchase of his/her minority stake in the business. In this situation, the majority owner may appear to be “stuck” with no recourse to force the exit of this bad partner and fix the problems the investor is causing at the company.…
Entrepreneurs launching new companies today take on a significant gamble, because statistics show that roughly 30% of all new start-ups fail within two years, and only half survive for a full five years. Many businesses fail due to the owners’ inability to meet the challenges of the marketplace, but some start-ups shut down when conflicts arise within the ownership group. Companies can go under over these ownership disputes even when their governance documents include dispute resolution provisions—if these terms fall short of keeping the business intact.
Given the many business risks that business entrepreneurs face, they should not also have to accept the gamble that a future serious conflict with their co-owners will torpedo the business. This post therefore focuses on dispute resolution terms that are designed to resolve ownership disputes, but which will preserve the continued operation of the business. While not fool-proof, the best mechanism for resolving ownership conflicts in our experience on a prompt, confidential and cost-effective basis is through a set of well-crafted fast track arbitration provisions. These arbitration terms are included in the company agreement (LLC’s), in the bylaws (corporations) or in the limited partnership agreement (limited partnerships), and they are discussed below.
Faster – Prompt Date for Final, Evidentiary Hearing
Litigation will often drag on for months and, in some cases, years, and at great cost. By contrast, arbitration is a dispute resolution procedure that is created by agreement of the parties, and as a result, the parties can choose to adopt a specific timetable in their arbitration provision that requires the final arbitration hearing to take place on a prompt schedule. The manner in which a fast-track schedule for the arbitration hearing plays out is described below.
After one of the parties files a demand for arbitration, the arbitration company, which is typically either AAA or JAMS, will assist the parties in selecting the arbitrator, or if the parties opted for a panel, a panel of three arbitrators, to preside over the dispute. Once the arbitrator or the arbitration panel is appointed, a scheduling conference will be held promptly, and the date for the arbitration hearing will be set at that time. If the parties require the hearing date to take place within a specified period in the arbitration provision, e.g., 60 or 90 days, the arbitrator or panel will enforce the parties’ agreement and adopt the schedule to which they agreed. In short, the parties will get what they bargained for, a prompt hearing with no delays/continuances. …
It’s my party, and I’ll cry if I want to
Cry if I want to, cry if I want to
You would cry too if it happened to you.
—Its My Party, by Lesley Gore
Almost five years have passed since the Texas Supreme issued its decision in Ritchie v. Rupe in 2014 abolishing shareholder oppression as a claim under common law by minority shareholders in private Texas companies. Specifically, in Ritchie, the Supreme Court eliminated a court-ordered buyout as a remedy for minority investors complaining of oppressive conduct by the company’s majority owners. The legal landscape remains bleak for minority shareholders, and when the five year anniversary of Ritchie arrives in June, minority shareholders still have no legal remedy to secure a buyout of their ownership interest if they failed to obtain a buy-sell agreement or other contract exit right at the time of their investment in the company.
In this blog post, we will review efforts made to address the problems created by the Supreme Court’s holding in Ritchie, both legislatively and in the courts, consider how the predictions the Court made in Ritchie have played out, and discuss the state of the current legal battlefield between minority shareholders and majority owners in Texas private companies.
No Legislative Fix for Ritchie Has Been Adopted or is Pending
In the aftermath of the Ritchie decision, the Texas legislature took a run at creating a statutory fix to address the Court’s removal of a buyout legal remedy for oppressed minority shareholders. In 2015, the year after Ritchie was issued, Rep. Ron Simmons, a second-term Republican from Denton County, introduced Bill 3168 in the Business and Industry Committee of the Texas House. This proposed Bill would have applied solely to closely-held entities rather than to all private Texas companies, and the provisions of Bill 3168 were broader than the pre-Ritchie state of the law.
More specifically, as originally proposed, Bill 3168 would have granted broad statutory powers to Texas trial courts, including the right to appoint a “fiscal agent” to report periodically to the court on the operations of the business. This new type of statutory agent is different than a receiver and would likely be more akin to a monitor. In addition, the Bill intended to provide the oppressed minority shareholder with more than a buyout right as it authorized shareholders to pursue a claim for a dividend to share in the retained earnings stockpiled by the company, as well as the right to recover damages from the majority owner and/or board members who engaged in oppressive conduct that was shown to be harmful to the minority shareholder.…
“The only way to get rid of temptation is to yield to it.” -Oscar Wilde
“I generally avoid temptation unless I can’t resist it.” -Mae West
“That which is hateful to you, do not do unto your neighbor.” -Hillel the Elder
Temptation is powerful. We all know this well, which is why these quotes by author and bon vivant Oscar Wilde, and actress and legendary sex symbol Mae West evoke nods of agreement. But giving into temptation can result in significant harm to ourselves and others. That is why more than 2000 years ago, the revered Jewish religious leader and biblical sage, Rabbi Hillel, implored his followers to treat others as they would want to be treated.
In the modern business world, temptation wins out when managers and majority members of Texas limited liability companies (“LLCs”) exploit their controlling power for their own benefit to the detriment of the company’s minority investors. These self-serving actions by governing persons may result in breach of fiduciary duty claims being filed against them, causing these governing managers or members to turn to the Texas Business Organizations Code (“TBOC” or the “Code”) in search of a legal defense. The TBOC does not provide governing persons with a “get out of jail free card,” but the Code does contain an “Interested Director” provision that may be helpful to LLC majority owners and managers who have to defend against breach of fiduciary duty claims. See TBOC § 101.255. This post evaluates the scope and the limits of the TBOC’s Interested Director provision.…
Hospitality – the friendly and generous reception and entertainment of guests, visitors, or strangers in which the host receives the guests with goodwill.
It is a common complaint that companies now provide a disappointing level of customer service. But merely providing good service is not enough for a business to be assured of success. In a superb article on the Skift hospitality website, 6 Basic Lessons in Hospitality From Danny Meyer, Deanna Ting summarizes a discussion held with Mr. Meyer at New York University in which he encourages businesses to go beyond service to providing customers with remarkable hospitality. Mr. Meyer is a renowned restauranteur and the force behind acclaimed New York based restaurants such as Shake Shack, The Modern, Gramercy Tavern, and Union Square Café.
Ms. Ting’s article reviews six lessons from Mr. Meyer on hospitality, which have broad importance for entrepreneurs. This post considers lessons for business owners from all types of industries from the discussion with Mr. Meyer at NYU and from his New York Times best-selling book, Setting the Table: The Transforming Power of Hospitality in Business. Mr. Meyer explains it this way:…
The majority owners of private Texas limited liability companies (LLC’s) enjoy a mixed blessing when they also manage their companies. Majority owners have the power to direct their private companies as they deem fit, but when they disregard the interests of minority owners, they may breach their fiduciary duties to the company. The members of member-managed LLCs and the managers of manager-managed LLCs owe their companies the fiduciary duties of care, loyalty and obedience under Texas law, which does not permit them to disclaim their fiduciary duty of loyalty. This post discusses significant legal and business issues faced by managers of Texas LLCs in guiding their companies to success while striving to maintain good relations with their minority owners.
Three significant legal and business challenges that LLC managing owners confront are: (i) the degree of control and extent to which minority owners are permitted to block major company decisions, (ii) whether majority owners have total discretion over profits distributions or whether a minimum requirement exists that requires profits distributions and (iii) the level of financial reporting requirements and related issues of transparency. In regard to these challenges, majority owners who do not unfairly exploit their control over the business, issue profits distributions when appropriate and engage in open communications are more likely to foster harmonious relations with all company owners through both good times and bad.…
For many company founders, the business they created is far more than an investment and is closer to a baby they have nurtured and supported. As the company achieves a significant level of success, however, the founders may not be quite as involved in day-to-day operations of the business. In this later phase, the owners may have retained an experienced CEO along with other senior officers who are striving to maximize the company’s bottom line while the owners focus on strategic alternatives and other opportunities outside the business.
It is at this point, when things appear to be running smoothly and company is on a profitable glide path, that the owners are stunned to learn that the rock star CEO they retained or one of the members of the CEO’s hand-picked management team is accused of sexual misconduct. This situation is becoming more common as the EEOC reported a 12% increase in the number of sexual harassment charges filed in fiscal year 2018. EEOC Preliminary FY 2018 Sexual Harassment Data (Oct. 4, 2018), https://www.eeoc.gov/eeoc/newsroom/release/10-4-18.cfm. What are the next steps that company owners should take when these allegations are made? The answer is of critical importance to the business, because the company’s stakeholders are watching how this is handled, including other employees, managers and customers. This post presents some important Dos and Don’ts for company owners to consider when faced with their #MeToo Moment.…
A look back at Business Divorce developments during Texas 2018 reflects a continuing negative trend for private company shareholders who have claims for misconduct against the company’s control group (e.g., majority owners, officers, managers, and/or directors). The rocky road for Texas shareholders began in 2014 with the Supreme Court’s Ritchie v. Rupe decision, which eliminated the remedy previously available to minority shareholders of securing a court-ordered buyout of their ownership interest upon proof that majority owners had engaged in oppressive conduct. The slope became even steeper in late 2018 with an appellate court decision requiring dismissal of shareholder derivative lawsuits if the shareholder cannot meet the “Continuous Ownership Rule.” See In re LoneStar Logo & Signs, LLC.
What are shareholder derivative lawsuits, how does the Continuous Ownership Rule apply to claims in these cases, and do private company shareholders continue to have the right to pursue valid claims for wrongdoing against the company’s majority owners, officers, managers, and directors? This post answers those questions, and the upshot is that the best advice for shareholders is to file their derivative lawsuit as soon as possible. While winning the race to the courthouse provides no guaranty that the lawsuit will be permitted to continue through trial, under the current Texas law, having a derivative lawsuit on file gives the shareholder the best possible legal and equitable arguments for maintaining the lawsuit to judgment.…