The Case for a Business Prenup

Author

Matthew Holt
March 17, 2024

I spent the first part of my career focusing primarily on business divorces – separating partners, corporate directors, members of an LLC, etc., when they reach a point of no return in their business relationships and must part ways. Much like a marriage, your business partner is someone who you should trust, respect, and support unconditionally. But we often look at business relationships differently, like they are merely a contractual relationship. Newsflash, you can strip down a marriage to merely a contractual relationship if you choose to.[1]

Like marriages, I have seen many of these relationships sour. I want to pause to share some good news: the divorce rates for marriages has declined over the last 20 years.[2] I have not been able to find the statistics for business divorces, let's just say - I have been busy.

The souring of these business relationship inevitably leads to a multitude of problems. First, the bank accounts and financials. One partner can take primary control of the bank accounts/financials and if that person is not you, you could be cut out of managing the company entirely. While it often leads to new claims, the potential for new claims does not deter people from using the company bank account as their own personal piggy bank. Companies also have internal systems that can be taken over where one partner takes control of valuable proprietary information. Not to mention other property like equipment or real estate… or cash. Taken cash is the one thing certified fraud examiners have an extraordinarily difficult time tracking. When issues in a business reach a breaking point, do not be surprised when a once-trusted business partner starts reaching for anything they can get their hands on. Control of the property or assets is leverage in these situations, and it is not rare for that leverage to be obtained and used improperly.  

However, unlike a marriage, issues can arise even when the relationship never sours.  For example, let’s say your business partner of 40 years is a business savant, but is unfortunately a poor parent who raises two knuckleheads. Without the proper business guardrails and structure in place, after forty years of success, you are now partnered with the knuckleheads. There is some nuance to this as most states, such as Arizona, have created laws that classify the knuckleheads as transferees. Transferees are prevented from managing the company. This statute is a relatively new creation and will take some more litigating to fully understand a member and/or managers duties to a transferee and the rights of a transferee, but I digress. Either way, without proper planning to preempt these issues, partners, and their knucklehead children, are left to statutes to guide them. The statutes in most states provide bare-bone corporate protections and structures, but they do not address all the issues described above, and when the drafters get around to fixing the issues from last set of rules, a whole new host of issues have arisen.

What options do entrepreneurs, founders, and builders have to preempt these issues, so they don’t end up in a courtroom helping to create new corporate laws by fighting with their once-trusted business partners?

Enter, the business prenup.

I believe humans naturally skew toward value creation and building rather than destruction. In my experience doing business divorces, partners are often left with one option – dismantle and wind down this once successful business. Tear it all down! This does not have to be the case.

Business prenups preempt any of these issues and prevent them from developing and devolving. They protect the business partners, and the underlying business itself. Business prenups often come in the shape of an operating agreement, but I like to think of them as something broader - any contract or provision entered into - to protect the business and the partners or cofounders.

I want out of the business because my partner decided he wanted to retire to Costa Rica and continue to collect distributions? There is a provision for that. My parent passed away, gave me their interest in this company, and the partner is not as forward thinking as I am? There is a provision for that. With a business prenup, contractual mechanisms are put in place that will protect the hard work the founders and partners have put in, protect the employees of the company, protect the capital investments, and in most cases, protect the relationship between the partners. Exercising contractual rights is inherently less souring for a relationship than litigation.

The point is, although you know your partner, you’ve vetted your cofounder, your gut never steers you wrong about these things – it is invariably difficult to know. Starting a business is inherently risky, limit the risk by entering into a business prenup. If you, your partner, or cofounder is uncomfortable discussing these risks at the outset, then is that the cofounder for you? Marriage or business, communication is foundational. You should explore how you and your cofounder communicate upfront in building the foundation of your company.

[1] Please see Aziz Ansari’s take on marriage: https://youtu.be/cYdsWtku9gg?si=Bj7fFp4s0TpOJZne