Avoiding potential deadlocks in your family-owned business
A deadlock in a business can occur when two owners, or groups of owners, are evenly split and can’t agree on a course of action.
When two unrelated parties form a business on a 50/50 basis, they are well advised to put a mechanism in place to deal with a potential deadlock. Many are unwilling to invest in that planning. And, in a family-owned business context, people seem even less willing to do this.
A first-generation family-owned business rarely has a deadlock situation because the founder typically has control. But, when shares have been transferred down two or three generations, a 50/50 split can occur. A deadlock can also arise when a business is owned by two separate families and, yes, it can even occur with a married couple.
Is a deadlock necessarily bad?
Some family-owned business owners deliberately leave control in equal shares among two siblings or cousins on the rationale that it will force the next generation to act by consensus. Sometimes that works. Sometimes it doesn’t.
While two siblings or cousins with a reasonable disposition and good relationship frequently can make this work, it is often just a matter of time before the smooth flow can break down.
Senior family members may believe that decisions regarding the business can be worked out among “family.” Even if that is the expectation, it is good planning to have a fallback in case a consensus cannot be reached.
When owners are unable to agree on material decisions, it can quickly jeopardize the survival of the business. This is especially true in today’s rapidly changing business climate in which a business needs to be constantly evolving to meet customers’ needs.
What are some possible solutions?
The Michigan Business Corporation Act allows a director or shareholder to seek dissolution of the corporation if the owners are “unable to agree … on material matters respecting the management of the corporation’s affairs” and, as a result, the “corporation is unable to function effectively.” However, a court-ordered dissolution is rarely a satisfactory outcome.
Board of directors. One solution is a functioning and properly structured board of directors. The governance documents for the entity can require an odd number of directors and can provide a mechanism to select other family members or, better yet, independent directors, who can act as a tiebreaker.
These arrangements are best implemented before a conflict arises but can still provide a helpful mechanism even when a conflict already exists.
Voting arrangements. Even if the equity of a business is to be evenly split, the use of voting and nonvoting interests permits control to be placed in just one family member or family branch.
As an example, I worked with a family that wanted to assure that one and only one family member would have complete control. The ownership interests were restructured so that four next-generation family members had one, two, four or eight voting shares and the father retained 16 voting shares (and most of the company value was represented by nonvoting shares that could be gifted to younger generations).
The Shareholder Agreement provided for the redemption of voting shares upon a death. Under this arrangement, there was always one owner who had enough votes to outvote everyone else.
Other arrangements can be established using a trust to hold voting shares or a voting agreement among the holders of the voting shares. Under these arrangements, a hierarchy or succession of family members (or even non-family) who will exercise control can be set forth. Even if the family isn’t in a position to create a specific list, a mechanism can be established for selecting a person who will exercise control.
Buyout arrangements. If shares have been left to two siblings, the family could put an agreement in place that permits one family member to trigger a buyout of shares.
For example, one family member could be permitted to set a purchase price and the other family member would be required to either buy or sell at that price. Remember “you cut, I choose”? A variation of this lets each family member submit a sealed bid (i.e., price per share or unit) with the person making the highest bid becoming the buyer and the other becoming the seller.
Arbitration. As a part of a shareholder agreement or other arrangement between owners, a family can require that deadlocks be resolved, and other disputes regarding the family business be addressed, through some kind of arbitration or mediation.
This might involve preselected arbitrators or mediators or can simply contain an agreement to participate in an identified mediation or arbitration process and to be bound by the outcome. Confidentiality can be preserved too, instead of a family dispute playing out in court.
Conclusion. While deadlocks can arise and be problematic in the context of a family business, some solutions are available. Most work best if they are implemented before conflict arises. The senior generation can put these arrangements in place before or as a condition of transferring ownership interests to subsequent generations.
Depending on the circumstances, these arrangements can be set forth in an entity’s governance documents (Articles of Incorporation, Bylaws, Operating Agreement), in a trust agreement, in a shareholder agreement, or in other arrangements between owners.
In any case, proactive advance planning can help avoid deadlocks and help assure the family business continues in the family for future generations.
Bruce C. Young is a third-generation shareholder, director, and secretary of The Behler-Young Co. He also serves on the board of the Family Business Alliance. His day job is as a partner with Warner Norcross & Judd, where he has served as a trusted advisor to family-owned businesses for more than 30 years. He can be reached at (616) 752-2144 or firstname.lastname@example.org.