Texas Business Dispute Blog

Wednesday, July 11, 2018

Agree on a Exit Plan in Advance.

"Would you tell me, please, which way I ought to go from here?"
"That depends a good deal on where you want to get to," said the Cat.
"I don't much care where—" said Alice.
"Then it doesn't matter which way you go," said the Cat.

Lewis Carroll's Alice's Adventures in Wonderland


Tip 4 addresses the most common problem facing minority owners in private Texas businesses: they invest with no plan and no path for exiting their investment. 

THE OLD WAYS DON’T WORK ANYMORE

A little history: Until 2014, if a minority owner in a Texas business was "oppressed" by a majority owner, the minority owner could sue under a Texas statute and a common law cause of action and seek a court ordered buyout of their interest. In the summer of 2014, the Texas Supreme Court, in  Ritchie v. Rupe, 443 S.W.3d 856 (Tex. 2014), eliminated the minority shareholder common law right to seek a buyout and interpreted the statute, Tex. Bus. Org. Code § 11.404(a)(1)(C), as only permitting minority owners suing for "oppression" to seek appointment of a receiver. We addressed those rulings in detail in this post
 
As a result of the Supreme Court decision in Ritchie v. Rupe, it has become more important than ever that persons considering taking a minority ownership in a private business include in their agreements a procedure for obtaining a buyout in the event they wish to exit the business. So important is this to minority investors that like a doctor telling you to eat more veggies, we have posted on the importance of buy-sell provisions, here, here, and here

THE IMPORTANCE OF A CORPORATE “PRENUP” BEFORE INVESTING

As explained in detail in our prior posts, a buy-sell or redemption agreement serves as a corporate prenup, allowing investors to agree before investing on the manner and means of any eventual exit on terms that everyone understands and agrees to at the outset.  Minority owners can invest with the certainty of an exit and knowledge of the circumstances that permit it. The business and other investors can manage cash flow and minimize disruption. 
 
KEY ISSUES TO ADDRESS IN A BUY-SELL

As addressed in detail in our other posts, some key issues to address in drafting the buy-sell ("BSA") are:

(1) Circumstances for triggering the BSA - this includes issues like: required time delay before exercise, death, divorce, departure as an employee, termination for cause, change of control, misconduct, drag-along/tag-along protections, and other circumstances that enable or require an investor to depart the business.
 
(2) Valuing the business -this includes the valuation procedure, reliability of financial reporting, and the measure of value to be used, including applicability of discounts for lack of marketability and control.
 
(3) Terms of payment - this includes payout over time or upfront, security for payment, voting rights, financing, and whether other owners or the company hold the interest.

In negotiating these terms, it's worth finding a solution that represents a relative compromise and fair treatment all around. Plenty of off-the-shelf buy-sell agreements in form documents offer to pay a departing investor their share of the book value or some other minimal valuation. But in practice, punitively low buy out values produce litigation not peace. The low dollar buyout financially incentivizes the disgruntled minority investor to sue to get leverage for a better deal rather than accept offered terms. 
 
Finally, even a fairly negotiated buy-out provision will be contested if the business's operations and finances are opaque or rife with self-dealing. Fair, expedient buy-out procedures go hand in hand with good corporate hygiene, which will be the subject of our final tip, #5, stay tuned.


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With offices in Houston and Dallas, Diamond McCarthy LLP assists a variety of clients with their Texas Business Divorce matters throughout Texas, including Austin, San Antonio, Midland, Fort Worth, Galveston, Amarillo, Abilene, and Waco.



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