Navigating 50/50 Partnerships
This week we’re learning about LLC operating agreements, specifically the problems with 50/50 ownership. In this article I will teach you how to solve those problems to make 50/50 ownership work for you and your co-founder.
The first step is to understand how LLC ownership works.
LLC Owners Have Economic Rights and Governance Rights
The key to understanding LLC ownership is understanding a simple principle: ownership of an LLC gives you two kinds of rights: (1) the right to a share of the profits of the business and (2) the right to govern the business as an officer, board member, manager, and/or voter.
The right to profits seems straightforward and easily divided 50/50 among two founders. However, the right to profits becomes complicated when the founders consider what will happen if one of the founders does not meet expectations or goes above and beyond expectations. Is there room for adjustment and nuance in the 50/50 division?
On the other hand, the governance and voting rights are complicated and not easily divided 50/50 among two founders. If the two founders disagree on a key decision, who will decide? Will one founder have authority over certain parts of the business while the other founder has authority over different parts of the business?
The Problems with 50/50 Ownership
I list below three common problems with 50/50 ownership, but there are many more problems to be solved with 50/50 ownership beyond this short list.
Labor – The first common problem with 50/50 ownership is that one of the founders often ends up doing more work than the other founder by a significantly higher margin than either founder expected. If this risk is not anticipated in the operating agreement, it can lead to an unfair arrangement, bitter resentment, and no easy contractual solution unless the two founders cooperate.
Funding – The second common problem with 50/50 ownership arises when both of the founders intend for one of the founders to invest additional money into the business, but the founders can’t agree on the valuation and other terms of the additional investment. If this risk is not anticipated in the operating agreement, it can lead to a cash flow problem for the business down the road when more capital is needed.
Operations – The third common problem with 50/50 ownership is that the founders often disagree on the operations of the business, especially the direction and mission of the business. In addition to large, fundamental disagreements between founders, even small, petty disagreements can cause an emotionally induced stalemate between founders. If this risk is not anticipated in the operating agreement, it will lead to a breakdown in the day-to-day operations of the business and an inability to set a long-term direction and mission for the business.
How to Make 50/50 Ownership Work
To solve the many problems posed by 50/50 ownership, ask your lawyer for solutions that have the following effect:
Delegating certain authorities to one, not both, of the founders
Delegating certain authorities to a third party other than the founders
Defining expectations for founder labor and founder funding
Explaining how economic or governance rights will be adjusted if expectations for founder labor and/or founder funding do not align with reality
Providing pre-approved options for a founder to sell shares to the other founder or a third party
The Bottom Line:
When you start a two-person business, it’s like getting married. Similar to marriages, some two person LLCs end in business divorce. Similar to marriage divorces, some business divorces are smooth, cheap, and painless while others are messy, expensive, and devastating to everyone involved except the lawyers getting paid.
The LLC operating agreement is your business prenup, among other things. Would you rather pay for a lawyer to do your business divorce or your business prenup?
Adam Yohanan represents entrepreneurs, investors, freelancers, startups, small businesses, artists, and entertainers in a wide variety of transactional and regulatory matters, with an emphasis on complex commercial contracts, business formations, corporate governance, M&A, finance, intellectual property, and entertainment law. His office can be reached at 212-859-5041.
This guide is meant for educational and informational purposes only and should not be considered legal advice. It is essential to consult with an attorney or other advisors regarding all legal and other important matters.
