How to Resolve Decisions in Deadlock
September 13, 2013 | By Kevin Vela
One may be the loneliest number, but two can be worse than one in the context of founders.
Because we represent so many startups and small businesses, we end up drafting a lot of closely held Company Operating Agreements/Shareholder Agreements. One of the key concerns in a company with only a few owners is the dreaded 50/50 vote – also known as a “deadlock.” How can a company make a decision if the owners can’t achieve the necessary consent required to make a decision? This comes up all the time, so I thought I’d share some of the solutions we suggest to our clients
Flip a coin
Flipping a coin has many virtues. It’s quick, simple, and most importantly, it’s cheap. For important decisions, however, relying on the flip of a coin might not be the best course of action.
Under this deadlock provision, if neither party can agree on a decision then each would submit a one-page memo to the other side explaining why his action should be taken. The act of preparing the memo is obviously time consuming, and oftentimes the side with less conviction won’t do it. The parties should agree on a deadline for when the memo should be due (i.e. within 5 days).
Third Party Advisor
Different from a mediator, this would be a pre-determined third party selected by both parties to break deadlocks. This person could be a colleague, a mentor, your attorney, or any other competent party. The third party would take into consideration the memos prepared by each party (discussed above) and would render a final decision within 10 days.
If each party is adamant that his course of action should be taken, and the simple methods discussed above do not resolve the issue, the parties could go to mediation. This is an expensive process that could easily cost each side $5,000. Oftentimes the cost leads to surrender of one of the sides.
Trigger the buy-sell agreement
A Buy-Sell Agreement, in a nutshell, is an agreement between co-owners that governs the purchase of one party’s entire ownership share in a business. Triggering the Buy-Sell Agreement is an extreme measure and is generally reserved when there exists a material disagreement regarding the operations of a company and all other measures have been exhausted.
Ultimately, it is important to have a plan in place in the event that a deadlock occurs. This will ensure that the company is able to function smoothly and helps protect against potentially expensive disagreements, allowing the company’s owners to focus on their overall business goals.
Posted in Company Agreement Series, Startups
Kevin Vela is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, mergers & acquisitions, corporate law, capital raises, and real estate investment activities. You can see Kevin’s attorney profile HERE.