More and more shareholder dispute litigations are settling earlier than ever before, which is obviously a good thing for anyone who does not want to pay a fortune in legal fees (i.e., everyone). The reason is simple – in all but a handful of business divorce cases, it is obvious to everyone involved that the oppressed minority shareholder will wind up on the receiving end of a buyout. So why waste substantial legal fees fighting against an inevitable outcome? But the manner in which a settlement is negotiated may not resolve the real issues, and can actually serve to make matters worse.
One client thought he had saved fees by having a deal all worked out before retaining a lawyer. The majority shareholder had agreed to the appointment of an appraiser, who would then determine the amount the minority shareholder’s interest was worth. There were just two minor problems with this approach. First, while the term sheet between the parties bound the minority shareholder to the value arrived at, it did not require the majority shareholder to purchase the minority shareholder’s shares at the appraised value. If the majority shareholder did not like the appraised value, he was free to ignore it, while the minority shareholder agreed that it set the value of his shares in the event of future litigation.
Second, this approach did not address in any way the minority shareholder’s chief complaint which was that the majority owner, who was in total control of the money and the books, had been taking far more than his fair share for several years. This included the usual complaints, such as that the majority shareholder overpaid himself, and kept family members on the payroll for no-show jobs, the company paid personal expenses, etc. When I asked the client how his “deal” compensated him for the monies taken over the years, he was shocked to learn that would not be taken into account in a business valuation, as he assumed it would. When I told him that such actions would be factored into the picture only if the parties agreed to a forensic analysis, he realized why the majority owner was eager to agree to this procedure in the first place.
The client was equally shocked to learn that the term sheet may be binding on him even though he never signed it, simply because he agreed to it via email. A crazy fact pattern allowed the client to get out from under that Draconian term sheet, and negotiations started anew. And while the client believed that he and his business partner were both negotiating without counsel, we later learned that the majority shareholder had counsel every step of the way.
If you negotiate your own buyout to settle a shareholder dispute – even if you do so before business divorce litigation is filed –you may save some money in the short term, but please remember that you often get what you pay for.