Close corporations and family owned businesses typically create and preserve important value for the family, in both personal and economic ways. These types of businesses can also be ripe with mismanagement, disappointments and potential disputes. As a result it is important to consider and document dispute resolution mechanisms ahead of time, typically in a shareholders’ agreement or limited liability company operating agreement. Below are several dispute resolution mechanisms to consider, preferably when first entering into a shareholders’ agreement or operating agreement, or when reviewing and revising such an agreement.

Dispute Resolution Mechanisms

It is critical to clearly articulate how disputes among the owners will be resolved.  There are a variety of different ways to address disputes, including:

• Using a resolution panel or advisory board. This panel or board typically would be comprised of individuals trusted by the business owners and familiar with the business and the industry. Alternatively each family faction could be permitted to appoint a member to the panel or board. The decision of the panel or board typically would be final and binding. The benefit of this strategy is it often leads to a swift, binding decision. However certain business owners do not like the idea of putting major decision-making authority into the hands of an outsider or third party. Further, it may be difficult to change the composition of the resolution panel over time, whether due to death or changes in the parties’ relationships.
• Non-binding mediation followed by binding arbitration. Often it can be advantageous for the disputing parties to undergo non-binding mediation as a means to resolve the dispute. A capable outside mediator, unburdened with familial history and interpersonal issues, can often help steer the parties to an amicable resolution. Failing that, binding arbitration can result in a path forward which often is accepted by all sides. Plus, unlike a lawsuit, both the mediation and arbitration proceedings have the benefit of remaining private.

Buyout Mechanisms

Particularly when the business is owned by multiple branches of the family, a formalized buyout mechanism can provide a resolution of last resort if the dispute cannot otherwise be successfully resolved. Buyout mechanisms allow business owners to buy out their co-owners so that the business can be operated on a go-forward basis without contention. Like dispute resolution mechanisms generally, there are a variety of different buyout procedures, including:

• “Russian Roulette”. One owner invokes the process by stating that it wishes to sell its equity to the other owner(s) at a stated price per share. The other owner(s) either can accept the offer to buy the invoking owner’s equity at that price per share, or must sell their equity to the invoking owner at that price per share. Since the invoking owner does not know whether they will end up selling or buying out their co-owners, the invoking owner is incentivized to establish a fair price per share. No outside valuation of the business is required in this scenario, eliminating a potential cost (and another potential dispute). One drawback to this process is that it can favor a party that has clearly more financial power than their co-owners.
• “Texas Shootout”. One owner begins this process by making an offer to buy the equity of the other owner(s) at a stated price per share. The other owner(s) either can accept the offer and sell to the invoking owner, or submit a counteroffer to the first party to buy out the first party at a higher price per share. This process then goes back and forth until an offer is accepted. Like the “Russian Roulette” process, this process dispenses with the need to obtain a formal valuation, yet the back-and-forth nature of this process is likely to result in a fair price per share. Also similar to the “Russian Roulette” process, this mechanism can favor a party with more financial power than the other, with that party likely to end up as the buyer and long-term owner of the business.

For these processes to work properly, business owners should document these provisions in the shareholders agreement (or LLC equivalent) before any issues arise. Implementing these procedures should be viewed as part of the critical planning for the future success and stability of the business.