It’s a scenario that is more familiar than not. Two parties, who are usually “friends” before going into business with each other, decide they want to start a business and, to be fair, they decide to each own 50 percent of the company.
Sounds great, right?
Wrong.
What exactly does 50 percent/50 percent (50-50) ownership mean? Does this mean that each will receive 50 percent of the profits, or that each will contribute 50 percent of the required capital, or even that each will have 50 percent of the management authority of the company? Not always.
Be very wary of a 50-50 split. Depending on how the corporate documents are drafted and who prepared them, 50 percent-50 percent isn’t always the best way to own a company.
Here’s why:
Profits split – If you have formed a corporation, a 50-50 ownership split means profits will be split equally. This is a positive part of the 50-50 split for a corporation. But what if you have formed the more popular limited liability company? An LLC does not require profits to be distributed in accordance with its members’ ownership percentages in the company. Therefore, the profits will be distributed in accordance with the company’s operating agreement, which is not always reviewed closely by its members before agreeing to its terms. Be aware of the language in the document that describes the “split” of profits in the company to ensure it is what the parties agreed to.
Contribution of capital — A 50-50 ownership structure doesn’t always mean that each will contribute equal amounts of capital to the company. In an LLC, one owner may be the “money member” and contribute a large sum of money to get the company going, while the other member may be the “services member,” where he/she provides the knowledge and services the company needs to operate. Therefore, be aware of how much capital each member/owner is expected to contribute and, furthermore, who gets to decide when or how additional capital is contributed. Is this a decision that can be made without the owners’ consent? If so, a 50-50 split may not mean much here.
Management of the business — In a corporation, the officers and directors make decisions for the company. Depending on your corporate documents, some decisions can be made by the officers and directors alone, and some require a vote of the shareholders. In an LLC, the company is either “member-managed” (in which case the members are all managers of the company) or the company is “manager-managed” (in which case manager(s) are named and those managers can take certain actions on the company’s behalf without a vote of the members/owners at all). Therefore, the ownership percentages may have no effect on the management of the company in a case such as this.
Deadlock provision — Finally, a 50-50 ownership split requires some type of provision in the company’s corporate documents that establishes the procedure to break a deadlock. What will happen if the owners, who presumably each have 50 percent voting rights, disagree on something? When this occurs, a deadlock can follow and you’ll need a way to resolve it. Otherwise, the company and its owners will end up in court, which is not ideal for many reasons.
Despite more cons than pros, some clients still insist that their companies be established with 50-50 ownership. There are not all bad things to come out of this structure. It does provide that the owners are equal “partners” and that each has an equal stake in the business. This often translates to each one having an equal vested interest in the success or failure of the business.
I advise my clients that although a 50-50 ownership split may work, it is crucial to have the proper documents in place just in case it does not. Regardless of the ownership structure of your business, you should always seek the advice of an attorney who practices in this area to guide you in structuring the company ownership and documentation and advise you about the risks and benefits of such ownership.
Brooke M. Borg is a partner with Las Vegas-based law firm Borg Law Group, www.borglawgroup.com. Reach her at 702-318-8808.