Succeeding in Your Business: Breaking up (without an agreement) is hard to do

“I am the 80 percent owner of a limited liability company (LLC) that runs an Internet marketing and website design firm. I basically do all of the work. My 20 percent partner only functions as a part-time intern, gofer, secretary or administrative assistant. We recently agreed that we should go our separate ways. I have five questions about the breakup.”

Before we answer them, I have to ask: Why, oh, why did you give a part-time admin 20 percent of your company? You should never, EVER give a piece of the pie to someone unless the person has something unique and significant to contribute to your business success. While not unimportant, admin people should be put on salary and paid a fair wage with benefits when you can afford them and given a W-2 at the end of the year. Yes, it hurts to use your precious cash to pay their salary and payroll taxes, and they’re entitled to unemployment compensation (you ARE making the weekly payments, right?). But it’s cheaper in the long run than making them partner because even a small percentage of ownership gets really expensive once your business takes off and becomes successful, as yours clearly has. Would you pay a part-time secretary $200,000 a year? Well, that’s what 20 percent of a service business is worth once it makes $1 million a year. Not bad for 10 hours of typing a week!

OK, now that I’ve got that off my chest, let’s turn to the five questions.

“1. My partner mentioned that she wants to keep our company logo and web address (URL). Who owns these?”

Your LLC owns all assets of the business, including any intellectual property, such as a logo, company name or website. Under no circumstances should your partner get ANY of your LLC’s intellectual property if you are going to continue the business. As a condition to your buying her 20 percent interest, you should get your partner to agree A. to assign to the LLC all of her “right, title and interest” to any property she may have developed for your LLC, B. to keep all of your trade secrets confidential, C. not to solicit your customers or otherwise unfairly compete with you after she leaves and, D. not to disparage or bad-mouth your business to others.

“2. With 80 percent of the LLC ownership, can I just fire her and continue running the LLC business myself?” 

Yes, but unless you buy her out, she will remain a 20 percent owner and be legally entitled to 20 percent of your profits at the end of each year, even though she didn’t lift a finger to help you. Not a good idea. Also, in some states (such as New York), she may be able to seek a court-supervised breakup and valuation of the business if she can prove “harmful and oppressive conduct” on your part.

“3. Should I just dissolve the LLC altogether and start a new business?” 

With 80 percent ownership of the LLC, you probably could do that legally, but then you would have to figure out which 20 percent of the LLC’s assets your partner is entitled to when the LLC is liquidated. That could get sticky.

“4. How do I value the business? Together we put $2,000 into the business. There’s $30,000 in the LLC checking account and about $40,000 in accounts receivable.” 

I would keep this very simple, since you’re too small to have a professional valuation done. Find out what your partner took out of the business in cash distributions last year (this will appear on Schedule K-1 of your IRS Form 1065), and offer her twice that amount. If that comes to less than $14,000 (20 percent of $70,000), offer her $14,000. If you can’t afford to pay a lump sum, offer to pay in monthly installments over the next year at 6 percent annual simple interest (0.5 percent per month).

“5. What do I do about new projects? Can I do these on the side or form a new LLC?” 

Unless there is a noncompete clause built into your LLC operating agreement, there is nothing to prevent either of you from doing things on the side, with or without the other’s knowledge. If you form a new LLC and start running a parallel business, though, your partner might sue you for improperly diverting assets and business from your old LLC or illegally freezing her out. Talk to your lawyer before taking a drastic step like that. I would strongly prefer that you buy her 20 percent interest, even if you have to pay more than it’s worth. You will sleep better at night.

Lesson: Once you make someone your business partner, there is only one way you can get rid of them legally and that is to buy them out for a price on which the two of you can agree. Before making ANYONE a partner, make sure you get a buy-sell agreement from them that spells out precisely how much they will be entitled to receive for their ownership interest if you decide they are no longer adding value. A good attorney can draft one of these for you for under $2,000.

Cliff Ennico (crennico@gmail.com) is a syndicated columnist, author and former host of the PBS television series “Money Hunt.” 

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