So, You’re Breaking Up?

Without proper planning, ownership splits and breakups aren’t always clean, and they often come down to a number or another settlement. Whether it’s a divorce, a falling-out between partners, a sibling who wants out, or an employee leaving with shares, someone has to figure out what that ownership is worth and how to pay it out. In this piece, we’ll walk through breakups we commonly see, who you’ll want on your team, and what you can put in place now to save heartburn later.

The breakups that put a number on the table

• +Divorce: when a spouse owns all or part of a private company, that ownership usually has to be valued as part of dividing the marital estate.
• +Shareholder and partner disputes: owners stop agreeing on direction, pay, distributions, or who’s in charge, and one or more owners want out, or the others want them out.
• +Family breakups: a sibling or other relative owns part of the business but isn’t involved in running it or no longer wants to be.
• +A partner leaving the cap table: retirement, death, disability, a new opportunity, or a termination can all trigger a buyout.
• +Employees with equity: an ESOP participant or a manager with incentive equity leaves, and the company has to cash them out.

Regardless of what leads to it, you end up asking the same things: what’s it worth, who gets to decide, and where does the money come from?

Why a valuation usually comes into play

A private company doesn’t have a public stock price to point to. Once a business reaches a certain size or complexity, attorneys, courts, and the owners themselves generally need an independent valuation to support the number. Even when everyone agrees on a price, a valuation gives the conclusion something to stand on if a court, the IRS, or another owner questions it later.

How it usually plays out

In a contested breakup, each side has its own attorney. Each side often has its own valuation expert too, who looks at the same company and reaches an independent opinion. Sometimes the parties agree on one neutral valuation expert, which can simplify things, but more often than not it’s side against side.

That means two reports, two sets of assumptions, and often two different conclusions. Along the way there can be document requests, management interviews, depositions, mediation, and, if it doesn’t settle, testimony at trial. Knowing that going in helps you plan your time, your team, and your expectations.

Who you’ll want on your team

Not every breakup needs every advisor, but these are the people who usually come into play:

• +Family law attorney: for divorces and many family breakups.
• +Business litigation attorney: for shareholder and partner disputes, and anything headed to court.
• +Corporate counsel: for the governing documents, the buyout agreement, and the ownership transfer.
• +Estate counsel: sometimes, when a death, a UHNW family, an estate, or a trust is part of the picture.
• +Valuation expert: to value the business and the specific ownership interest, and to support how they got there.
• +Forensic and litigation specialist: sometimes, when the books are in question or someone suspects income or assets aren’t being reported, or for specialized analyses.
• +CPA and tax advisor: for financial statement support, and because buyouts and transfers carry tax consequences for both sides.
• +Financial advisor: to help you and your family plan for what comes next, whether that’s managing a payout, a note, or a bigger stake in the business, and to connect you with financing when a buyout calls for it.
• +ESOP team (for ESOP companies): the ESOP trustee, ERISA counsel, the third-party administrator (TPA) that keeps the plan records and processes payouts, and any independent director or other fiduciary on the board.

Who sees what

Information is a big pressure point in any breakup. Majority owners, and anyone running the business, generally see everything: the books, the bank accounts, the contracts, the projections, and the day-to-day decisions. Minority owners often see much less. Depending on state law and the company’s governing documents, a minority owner may have the right to request certain records, but that access can be limited, slow, or argued over.

That changes once a dispute goes to litigation. Through discovery, each side can generally request documents and information relevant to the case, so a minority owner may end up seeing far more than they ever did before the dispute. If you’re the majority owner, plan for that and keep clean, well-documented books long before there’s a dispute. If you’re a minority owner, know your rights under your operating or shareholder agreement and work with counsel on what to request.

Standard of value and discounts, briefly

The same shares can carry different values depending on why they’re being valued. A divorce, a shareholder dispute, and a buyout under a buy-sell agreement can each call for a different standard of value, set by state law, a court, or the agreement itself. This is covered in more detail in Are All Valuations the Same?

One of the biggest swing factors is whether discounts apply. A minority stake that can’t easily be sold is often worth less per share than a controlling stake, through discounts for lack of control and lack of marketability. Whether those discounts apply in a breakup depends on the purpose, the jurisdiction, and the documents. That one question can move the number a lot, so it’s worth understanding early.

Be mindful of personal goodwill

Goodwill is the value of a business beyond its hard assets. In many closely held companies, especially professional practices and owner-driven businesses, part of that goodwill is tied to one person: their relationships, reputation, and skills. That’s personal goodwill. The part that stays with the business no matter who runs it is enterprise goodwill.

In a divorce, the difference can matter a lot. Many states treat personal goodwill as belonging to the individual and leave it out of the marital estate, while others include it. The rules, and how courts apply them, vary by state and can be nuanced, so talk with your attorney about how your state handles it before assuming either way.

Personal goodwill isn’t only a divorce issue. It also comes up in business settings when one key partner drives most of the relationships or revenue. If that person leaves, some of the value may leave with them, which affects what their ownership is worth and what the remaining owners are actually buying. Non-compete and non-solicitation terms, where state law allows them, often become part of that conversation.

Family breakups and the silent owner

Family businesses carry a different kind of weight. A common version is the silent owner: a sibling or other relative who owns part of the company but isn’t involved, for whatever reason. Maybe they inherited their stake, maybe they stepped away years ago, or maybe they need cash and want out. Meanwhile, the family member running the business wants control so they can make decisions without needing sign-off from someone who isn’t there or doesn’t understand the business.

None of that required bad intentions from anyone. A few conversations and a few documents, years earlier, could have changed how it went.

If you’re buying out a sibling who isn’t involved, you’ll generally want family law counsel, estate counsel, and a valuation expert who understands the company, what that sibling’s ownership is worth, and how minority and controlling stakes play into it within your ownership structure. A 50/50 split, for example, has its own dynamics, since neither owner has control on their own. Good legal planning and a well-supported valuation can protect the business and the relationship.

Shareholder disputes and dueling experts

When partners fall out, it’s usually over control, compensation, distributions, or where the business or partner is headed. Sometimes an owner feels pushed out or shut out of decisions. If it can’t be worked out, the question becomes what the owners’ shares are worth and who has to buy them. Depending on state law, especially when a minority owner claims they’ve been treated unfairly, a court may also have other options, including ordering a buyout or, in some cases, dissolving the company.

This is often where dueling experts come in. Two qualified valuation experts can look at the same company and land in different places because they make different calls on projections, normalizing owner pay and one-time expenses, the valuation date, and whether discounts apply. A judge or arbitrator decides which assumptions and analysis hold up better, and in mediation, some of those factors get negotiated. A report that’s well supported, consistent, and clearly explained is the one that holds up.

When employees with equity leave

In an ESOP company, participants who leave, retire, or pass away are generally entitled to be paid for the vested value in their accounts. Plan rules can delay those payouts, but because private company shares can’t be sold on the open market, they eventually have to be bought back, by the company or by the ESOP using company cash. That’s the repurchase obligation, and planning for it ahead of time protects your cash flow.

Private companies without an ESOP face similar questions when an employee or owner with equity leaves. Depending on the plan and governing documents, the company may have the right, or the obligation, to buy the shares back, or the person may be able to keep them. Vesting, the buyback price, and payment terms are usually spelled out in those documents, and setting the price often calls for a valuation. For more background on alternative equity and compensation structures, see Incentive Equity Explained.

Before the breakup: buy-sell agreements

The best time to deal with a breakup is before it happens. A buy-sell agreement, sometimes built into an operating or shareholder agreement, sets out what happens when an owner leaves, including who can buy, at what price, and how it gets paid for.

What triggers a buyout

Common triggers include death, disability, divorce, retirement, termination, a dispute, a voluntary exit, and a deadlock between owners. The agreement should spell out which events apply and whether the buyout is required or optional. Some agreements also include a deadlock clause, sometimes called a “Texas shoot-out,” that forces one owner to buy the other out. These have to be in place before a dispute, and they can favor the owner with deeper pockets, so set them up with counsel.

A clear valuation clause

This is where many agreements fall short. A good valuation clause covers:

• +Who performs the valuation: a neutral independent expert or one expert per side with a tiebreaker or a negotiated result
• +The standard of value, and whether discounts apply
• +The valuation date
• +How often the value is updated, since a fixed price set years ago can easily become a source of disputes
• +What happens if the parties disagree with the result

How to fund it

A buyout price doesn’t mean much if no one can pay it. Common ways to fund a buy-sell include:

• +Life insurance: to fund a buyout when an owner dies. How the policy is owned and structured can affect taxes and even the value of the company itself, so set it up with your estate counsel and CPA.
• +Disability buyout insurance: for when an owner can no longer work in the business.
• +Company cash reserves: money set aside over time for future buyouts.
• +Installment payments: a note paid over several years, which spreads out the cash but leaves the departing owner waiting to be paid.
• +Outside financing: such as a bank loan, if the business can support it.

Have the conversation

Documents only work if the people behind them have talked it through. Have these conversations at the dinner table or with your other equity owners. Who actually controls the business? What happens when you disagree? How does someone get out? And if it ever went to court, what would that cost you, not only financially, but in your relationships?

This article is a general overview for educational purposes only and is not tax, legal, accounting, or investment advice. Every plan is different, so talk with your advisors before making decisions. If you don’t have the right team in place, reach out and we can help you build it.

The bottom line

Breakups happen in every kind of business, and they’re harder when nobody planned for them. If you’re heading into one, get the right team in place early and understand what drives the number. If you’re not there yet, now is the time to put the infrastructure in place, make sure it defines how the value gets set and funded, and have the difficult conversations that are easy to put off. It can save your family, your friends, and your partners a lot of grief.

ProDelta Advisors values ownership interests for divorces, disputes, buyouts, and buy-sell agreements, and works with families as an outsourced advisor to help them plan, build the right team, and get through the process.