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In recent years, the headlines have tracked the news of high-profile breakups among business partners in private companies. These business partner fallouts include:   

  • 2023: Sam Altman was ousted as Open AI CEO (for less than three days) before he was brought back in a dramatic return to the company where he remains today.
  • 2022, Republic First Bank CEO Vernon Hill resigned after a power struggle with insiders that lasted for months, including with the bank’s founder, Harry Madonna.
  • Also in 2022, real estate developer Steve Ross, chairman of New York-based Related Companies, ended his longtime business relationship with partner Jorge Perez, chairman of Miami-based Related Group, which they said publicly was amicable.  
  • Finally, in 2020, Forbes reported: “Perhaps no duo on Wall Street has ever soared higher and broken apart quicker than the partnership between billionaires Robert F. Smith and Brian N. Sheth, the co-founders of Vista Equity Partners.” 

Reflecting on these business partner breakups made me think of Leslie Gore’s golden oldie, which still remains popular today: “It’s my party and I’ll cry if I want to.” These high-profile splits among business partners create notable headlines, but with some planning they may be avoidable. Even when a business divorce does become necessary, it doesn’t have to result in tears and trauma for the partners or for their businesses. In this new post, we review steps for business partners to consider that can help avoid conflicts, but which will also provide a more peaceful path to an exit if one of the partners ultimately decides to leave the business.

Document Essential Terms in Writing

The venerable Western saying is good fences make good neighbors. In business, good agreements make for good partnerships. To avoid/lessen conflicts, business partners need to put their agreements in place on key terms that address who controls the business and its operational structure. These terms include: (1) who decides key issues such as compensation, (2) whether to issue executive bonuses and distributions/dividends to owners and in what amounts, (3) whether major company decisions should be made by a bare majority of owners, by unanimous consent of all owners, or by a super majority percentage, (4) if the decision-making structure can lead to a deadlock between the partners on key decisions, what mechanism exists to permit the partners to break the deadlock (a third party will likely need to be involved), and (5) whether to appoint and give authority to independent board members or managers who can provide objective input to the partners (co-owners) about significant issues. 

No business operates without facing challenges, some quite serious. For business partner owners to surmount these challenges, they will be helped greatly if they have created a decision-making structure that includes third parties who provide input and recommendations based on their own track record and experience. Further, partners who look ahead and seek to reach agreement on management and control issues in the business before conflicts arise can avoid more serious disagreements.   

Negotiate and Adopt a Business Prenup

There are many anecdotal stories about business partners who worked their entire adult lives together after starting up a private company before they finally sold it or passed it along to their children. Those are heart-warming histories, but they are the exception, not the rule. In most cases, business partners do not stay together for decades; instead, partners will come and go and transitions are not unusual. For this practical reason, business partners should consider entering into corporate prenups with each other when the company is first formed or when a new business partner makes an investment into an existing business. This is an opportune time to enter into this type of agreement governing the exit of a partner as they are focused on the future success of the company and generally have a positive view of each other.  

There should be a mutual interest by both company owners and investors to enter into this corporate prenup, which is generally set forth in some form of a buy-sell agreement (BSA). For majority owners, the benefit of securing a BSA is that it provides the owner with the authority to redeem the ownership interest of a minority partner even if that partner doesn’t want to leave the business. No private company majority owner wants to be stuck in business with a minority partner who is dysfunctional, disruptive or, worse, directly interfering with the operation of the business. The BSA therefore provides the majority owner with a “call right,” which permits the owner to secure an involuntary exit of the minority investor if the need arises. 

For minority investors, the BSA will also provide them with a critically important benefit. Specifically, the BSA provides the minority partner with a guaranteed way to monetize his or her ownership interest in the business. In the absence of a BSA, the minority investor will not have the right to exercise a “put right” to obtain a redemption, and the investor may therefore be stuck for years holding an illiquid, unmarketable ownership interest in the company.

Negotiate a BSA That Meets the Needs of All Partners

The BSA will address all of the following issues: (1) when can it be triggered by the majority owner or investor, (2) how will the value be determined of the minority ownership interest that is being redeemed, (3) how will the payment be structured to the investor for the interest that is held in the business, and (4) what dispute resolution procedure will govern the enforcement and application of the BSA between the partners.

These issues need to be addressed right at the outset of the investment, and they need to be carefully evaluated to meet the business objectives of both parties. For example, the parties may decide that the BSA cannot be triggered for some period of years after the investment is made. This is referred to as a “delayed trigger,” which will allow time for the company to grow in value after the investment has been made before it can be redeemed or sold. Both the majority owner and the minority investor may therefore be required to wait three, four or even five years before either side can pull the trigger to either redeem the interest held by the investor or to secure a buyout of the investor’s interest in the business. 

Given that the majority owner also has a redemption right, the investor will want to be sure the majority owner’s right to redeem (purchase) the interest held by the investor in the business is subject to a “lookback” provision. This term protects the investor in the event that the business is sold not long after the investor’s interest is purchased by the majority owner (lookback provisions often last for at least one full year after the redemption of the investor takes place). If the business is sold during the lookback period for a higher value than the investor received in the redemption, this provision will require the majority owner to issue a true-up payment to the investor to ensure that the investor receives the benefit of the higher valuation that was achieved when the business was sold.

Conclusion

Business partner breakups will continue to make headlines, especially when they involve high-profile figures at large companies. But business partners who engage in advance planning and take steps to address internal governance issues can avoid the conflicts that lead to a business divorce. This type of advance planning, including the adoption of a well-crafted BSA, will also lessen the heartaches and headaches if a business divorce becomes inevitable.

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Investments in private companies should continue to flourish in 2025 in light of the revenue and EBITDA growth they delivered this year, and this rosy financial outlook is also confirmed by company leaders. According to a KPMG report in September, 90% of leaders they surveyed in U.S. private companies reported strong optimism about their future growth prospects. For investors, the private company sector remains attractive, but these are not risk-free opportunities. This post reviews three resolutions for investors to consider to limit their downside in pursuing private company investments in 2025.  

Resolution No. 1: Due Diligence Remains Essential

“All that glitters is not gold” captures the importance of conducting due diligence before making any private company investment. Three different aspects of due diligence, reviewed below, will assure investors that they are obtaining the information necessary for them to make an informed investment decision.  

First, due diligence involves more than a cursory look at the company’s financials. In this regard, investors will want to consider: (1) the company’s expected revenue growth (the pro forma) and where that growth will come from, (2) the projected expenses of the business and (3) the competitive landscape. In each case, the question is whether the company’s plan for success is both realistic and achievable.

Second, companies are not just balance sheets or income statements; they are composed of people pursuing business goals in a competitive marketplace. This aspect of due diligence focuses on the business leaders and their teams. Some of the key questions here are: (1) do the leaders have a track record of success, (2) are they not just passionate about the business, but also creative and adaptable in the way that they address challenges; and (3) are they transparent about how they are operating the business? Negative answers to any of these questions will raise red flags.

Third, are there difference makers regarding the business that make it attractive or suggest it is one to pass on?  Positive difference makers may include things like an impressive patent portfolio, a strategic relationship with an established business, or a first-mover advantage in an emerging industry.  Some negative difference makers are internal conflict among the existing owners, ongoing litigation against the company or threatened claims, or high employee turnover.  Each of these difference makers needs to be explored in more depth to gain a fuller understanding of the business before investing.  

Resolution No. 2: Meaningful Participation in Company Governance

“He who has the gold rules,” and investors holding a minority ownership will not have the right to direct how the company will be governed. That does not mean, however, that investors should be completely shut out of governance. The balance to be struck is for investors to insist on securing approval (veto) rights over major decisions by company management. These rights will be on the table in the negotiating process.

The veto rights sought by investors would include the right to approve the following: (1) the issuance of additional equity that dilutes the investor’s ownership interest, (2) taking on substantial additional debt, (3) selling significant company assets, and (4) amending the operating agreement. This short list of approval rights is a bare minimum, but securing these types of veto rights helps to reduce the risk of the investment.     

Resolution No. 3: Securing a Buy-Out Right

This may be the most critical resolution for investors to make before investing in a private company.  As Willie Nelson might have sung: Mamas don’t let your babies grow up to minority investors without a buy-sell agreement in place. A minority investor who does not have this exit right is likely to be stuck holding an illiquid, unmarketable interest.  The lack of a buy-sell agreement becomes even more of a problem if the investor becomes dissatisfied with the company’s direction and wants to secure an exit from the business.

The buy-sell agreement negotiated by the investor needs to cover the following issues: (1) when can the investor trigger the buyout (the investor may need to wait for some period before exercising the buyout right), (2) how will the value of the investor’s interest be determined, (3) what is the structure to pay the buyout amount and (4) what happens in the event the company defaults in payment.  Value is the most critical part of the buy-sell agreement, and the investor needs to require that the value of its interest is not subject to minority discounts. These discounts are based on the lack of marketability of the interest and the investor’s lack of control over the business, and they will be substantial if they are not excluded from the valuation of the minority interest. 

Conclusion    

Private company investing holds the promise to deliver outsized financial returns for investors, and that is likely to continue next year.  But this can be a high risk/high reward strategy, and investors who act with resolve will help minimize these risks.  Specifically, investors who conduct thorough due diligence, acquire approval rights in the governance documents and obtain a contract exit right will be better positioned for success.

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Delaware Chancellor Kathaleen McCormick held again last week that the pay package that Tesla’s board of directors awarded to Elon Musk in 2018 suffers from “fatal flaws,” and it was therefore rejected. This was the second time Judge McCormick reached this same result, and she issued her new ruling despite the fact that, after she tossed out Musk’s compensation plan back in January, the Tesla shareholders then voted overwhelmingly in June (by more than 70%) to approve the full stock award that the company’s board had granted to Musk. There is little doubt that Musk is a unique figure, and it is also significant that Tesla is a public company, but looking under the hood of the Musk/Tesla compensation battle provides some valuable lessons for non-public companies and their majority owners.

Some would say that with Musk at the steering wheel, Tesla is driving the “diva model” of company leadership. Whether one agrees with Judge McCormick’s rulings or thinks she overstepped her authority (Musk has made his position clear by pledging to move Tesla to Texas), her decisions highlight what constitutes good corporate governance, which applies to both public and private companies. As discussed below, committing to board independence, focusing on leadership that recognizes teamwork and building a strong company culture is an approach that will benefit companies of all sizes. 

1. Appoint and Foster an Independent Board

The importance of independent board oversight cannot be overstated. No majority owner of a private company needs to cede control over the business to an independent board, as this is not required for effective company governance. But majority owners and their companies do benefit when their boards are not populated solely by their family members and close friends. Specifically, owners will obtain an invaluable perspective and hard-earned insights from board members who have a track record working in the industry, have served on other boards, and do not shy away from offering their views about the company’s plans and operations.

It is not hard to understand why Judge McCormick questioned the independence of the Tesla Board members. Musk’s brother, Kimbal Musk, is one of five Tesla Board members with close ties to Musk, which include financial relationships with his other businesses like SpaceX, the rocket company. The court’s opinion from January set forth these concerns. 

The process leading to the approval of Musk’s compensation plan was deeply flawed. Musk had extensive ties with the persons tasked with negotiating on Tesla’s behalf. He had a 15-year relationship with the compensation committee chair, Ira Ehrenpreis. The other compensation committee member placed on the working group, Antonio Gracias, had business relationships with Musk dating back over 20 years, as well as the sort of personal relationship that had him vacationing with Musk’s family on a regular basis. The working group included management members who were beholden to Musk, such as General Counsel Todd Maron, who was Musk’s former divorce attorney and whose admiration for Musk moved him to tears during his deposition. In fact, Maron was a primary go-between Musk and the committee, and it is unclear on whose side Maron viewed himself.

For the majority owners of private companies, securing a board that is truly independent avoids these types of conflicts over decisions regarding the executive’s compensation. Just as importantly, an owner who receives input from an independent board is positioned to accomplish the company’s goals more quickly, while also steering past avoidable mistakes.

2. Share the Wealth with Others

The second point goes beyond fairness. Given the staggering appreciation in the value of Tesla’s stock during Musk’s tenure, there are strong arguments to justify his unprecedented pay package. But a different question is whether any company leader should receive compensation that is drastically higher than all other executive team members, who also contributed to the company’s success. By analogy, consider the lead singer/songwriter in a rock band who writes all the band’s songs and therefore receives royalties that provide him with compensation vastly greater than all other band members. The lead singer/songwriter can certainly justify his outsized compensation, but if he declines to figure out how to share royalties or other income streams more equitably, he will likely find himself becoming a solo artist on his next tour. 

Turning back to business leaders, even when a CEO is vital to the company there are other stakeholders in the company, who also play a meaningful role in helping the business achieve success. If the compensation of the other executive team members is dwarfed by the CEO’s pay package, they are likely to look for other places where they feel more valued. It also goes beyond the amount of the compensation because a CEO who takes all the credit and fails to recognize the contributions of others will not maintain a long-lasting team. Finally on this point, a CEO who receives an extremely high level of compensation will become a target much more quickly. The patience of the board and shareholders will run out much sooner when the high-paid CEO fails to consistently deliver extraordinary results.

3. Develop a Culture of Collaboration, Not Conflict

The third point relates to creating a successful company culture. In Musk’s case, Tesla’s board has largely given him free rein to run the company as he deems best as CEO, but he has had contentious relationships for many years with other officers, employees and stakeholders. It should be noted that this type of leadership conflict may not derail the company, and Tesla continues to perform well in the public market (in 2024, its stock began trading below $250 but is now closing in on its record high of almost $410 reached in 2021).

Notwithstanding Tesla’s notable success, most majority owners would prefer to govern their companies through collaboration rather than conflict, which requires focusing on collective efforts that celebrate teamwork. At a granular level, teamwork requires the owner to facilitate open lines of communication, to conduct decision-making through consensus and to maintain transparency throughout the process. This multi-faceted process may slow down the time for making key decisions as it requires more input and deliberation. When the members of the executive team have meaningful roles, however, and they are permitted to participate in the decision-making process, that will create strong buy-in. A collaborative company culture will sustain the company during good times, as well as through challenges, and the majority owner will not have to go it alone. Instead, the company’s success will be shared by the entire team.

Conclusion

The stock award granted to Musk at Tesla is so extraordinary, the legal conflict it has led to in Delaware has generated ample headlines. In more simple terms, however, the underlying dispute in the Musk case raises broad questions about how companies can be run effectively, including private companies controlled by founders. Although the diva model has worked well for Musk as a singular talent at Tesla, this approach may not provide majority owners in private companies with the best opportunity for success. Instead, majority owners may want to consider: (i) establishing a board that provides them with the benefits of independent judgment and input, (ii) creating a compensation structure designed to allocate financial rewards more broadly for all executives and (iii) fostering a culture of collaboration so that the company’s success is truly a product of teamwork.

Musk may well prevail in Delaware and finally receive his enormous stock award from Tesla after years of litigation. Whether private company majority owners would prefer to avoid this drawn-out legal conflict with their shareholders is worth considering, as well.