The importance of having a partnership or shareholder agreement cannot be overstated. Perhaps you’ve already realized this — albeit too late. You need to get rid of a shareholder now, but you don’t have the backing of an agreement to light the path to their exit ramp.

Penning a partnership agreement has likely been on your mind since you started your  company, and yet you still haven’t gotten to it. And even if you do have an agreement in place, you remain unsure of its efficacy. Will its guidance prove sufficient now that you need to fall back on it? 

These are common refrains from shareholders (at least those unaccustomed to dealing in the law and corporate finance on a daily basis). 

Below, we’ll discuss why it is so crucial to have partnership agreements and what you should keep in mind as you create or ameliorate yours. We’ll also detail six options to oust a partner without an agreement. This isn’t a pretty topic, but it’s a critical one to approach. 

The ideal scenario: your bulletproof shareholder agreement

In a perfect world, you already have a comprehensive agreement in place about your business partnership. At the very least, you can get one written and signed before you require its guidance. 

As you look to proof or produce yours, know that a model partnership agreement answers questions such as: 

  • How do we, as a partnership, run our business?
  • What will be our meeting cadence?
  • What is the process for approving accounts?
  • How will we value our business?
  • How will we split our shares?
  • What do we do if we need to terminate a partner?

It’s also a best practice to stipulate that your shareholder group will attempt mediation instead of, or at least before, resorting to litigation. Don’t forget: You were an amicable team at one point; ugliness should be avoided if at all possible.

The unexpected occurs: your partner must go

The final two questions in the above list (how will we split our shares and what do we do if we need to terminate a partner?) are the most contentious. They’re also the most important to put in writing. While every partnership is born of promise, the need to unseat a shareholder happens all the time. So even if it is wholly unimaginable to you right now, you must prepare for the unexpected. 

It could be an unforeseen death that necessitates the guidance of a partnership agreement to divest a shareholder. More likely, though, is that one party simply and surprisingly stops pulling their weight. 

The primary function of a partner in a capital-light business — one that operates exclusively on working capital — is to work. It follows that, if they’re not hustling, they must go. It’s only fair. 

The harsh reality is that most partnerships don’t function beyond the 10-year mark. It’s up to you to be hard headed enough to anticipate life’s happenings. Plan for the removal of a partner, however uncouth it feels.

The harsh reality is that most partnerships don’t function beyond the 10-year mark.

6 options to oust a shareholder outside an agreement

Let’s assume you don’t have a partnership agreement to dictate how to get rid of a shareholder. Hopefully you do have an operational one that allows you to come to a simple majority and fire someone. So, said shareholder is fired. However, now you have a person sitting on your shareholder slate who is no longer working. Resentment among the remaining, hardworking shareholders will mount — not to mention waste in continuing to support the ousted person’s shares. 

What’s next? Consider the six options below to officially offload a shareholder. 

1. Bear the weight of your sunken shareholder

Your first potential path requires no action. You and any other remaining shareholders simply accept that, while the ex-partner no longer works for your company, they’ll maintain their share in it. Legally, they’re entitled to this compensation since you don’t have an agreement stating otherwise. 

Admittedly, this isn’t a great option. Resentment will continue to build on the side of the operating partners. Such resentment ultimately poisons company culture. Still, we’d be remiss if we didn’t at least offer this quick-though-painful possibility.

2. Sell your company and start again

You always have the option to sell the business. This is perhaps the cleanest road to resolution. Everyone gets out, and selling has the added benefit of allowing you and your past partners to begin again with new (and separate) business ventures. 

The wastefulness of this path is upsetting, however. You’re throwing your company’s hard-built infrastructure to the flames along with your employees and clients.

3. Agree to resign and entreat an external CEO

In this scenario, every partner agrees to resign their post. Everyone is rendered a non-participating shareholder. Then, you recruit and hire an outside CEO to run the company. 

This is an expensive option because you’re paying said CEO. It also depreciates the value of your business. That said, if the remaining partners are unwilling to do the work while the ousted one sits idle, this isn’t the worst choice. It allows you to retain the asset you built together.

4. Adjust partner distributions

Forging a war of attrition is also an option. Basically, you use the power your operational agreement allows you to make decisions about partner distributions. You can circulate money within your business instead of paying it out to the underperforming partner. 

Similarly, you could vote to massively increase your salary and dilute the other person’s. Yes, you’re diluting yourself as a shareholder in the process, but you’re not losing that value. You’re simply transferring it to your salary as a (fully taxable) bonus of sorts.

Be warned that this siege mentality will absorb a great deal of energy. You’ll have to conduct an arduous shareholder meeting to gain approval to redistribute funds in this way. And it could end with the departing shareholder becoming angry — and litigious.

5. Procure your partner’s shares

This next option emulates John Rockefeller as he built up Standard Oil. 

Rockefeller played the long game, letting his partners and competitors know they could sell him units of their partnerships and businesses at any time. As his associates became wealthier and wealthier, predictably, they wanted for more and more. To attain their brownstones and yachts, these shortsighted partners sold shares to Rockefeller, who made the exchange seamless so they’d come back to offload more. Rockefeller paid them on the spot and acquired business units in return. Ultimately, he went from being a one-fifth partner to a majority owner over the course of about five years. 

You could do the same. Be steadfast in your patience. Wait for the problematic partner to become bored. Make it easy to do business with you. Retain liquidity. In time, you’ll possess their shares. 

6. Redefine your business model to support a classic investment partnership

This last option, if you can pull it off, provides all parties involved with the most value. 

Say you are one of two partners. You’re the partner who’s in the weeds doing the work, and you’re angry at your counterpart for resting on their laurels. Start negotiating with them by nailing down how much value you’ve created together. 

If your firm is worth $5 million, you each have $2.5 in the company. Propose treating your partner as silent while you assume the role of general or managing partner. As such, you’ll each deal with your $2.5 million in profits differently. 

Imagining the limited return on a partner’s investment is $500,000, your business must make $500,000 in profit annually to satisfy this return. Now, make the deal so you, as the general partner, gradually gain an increasing portion of the surplus over and above that $500,000. 

Over time, your silent partner won’t own as much of the business, yet your interests are in complete alignment. You both want the highest possible return on equity, only you stand to acquire more and more of the business as it becomes increasingly valuable, assuming you perform well. Meanwhile, your partner will see an increase in the value of their shareholding. It’s as close to a win-win as you can get. 

Your last resort

You have options to expel an underperforming partner from your shareholdership, but the ones we’ve listed assume you have an operational agreement that allows you to fire said partner, even though you don’t have a shareholder agreement. 

If you’re lacking a sufficient operational agreement in addition to a shareholder agreement, you have two final paths from which to choose:

The first path is as it sounds: One partner takes the business from everyone else. There’s a liquidity event, and then others are free to set up their own businesses elsewhere. 

The second one, a Texas shootout, is another viable option given the described circumstances. Basically, you and your partner(s) agree that, at any point and without reason, one partner can make an offer to acquire the shares of the other partners. The other partners have two weeks or so to either accept or reject the offer. If they accept, the partner who initiated the shootout now owns one hundred percent of the company. However, if they reject, they can take the initiating partner out at the same price proposed. 

The point of a Texas shootout is to force a deal, and to force the partner who truly wants the business to make an offer the others cannot refuse. This may sound unorthodox, but a Texas shootout is actually a worthwhile option to include in a partnership agreement, or to pursue if you don’t have one.

You’ll never regret planning for tomorrow

You need a mechanism in place to remove an underperforming shareholder. Ideally, your shareholder agreement contains this mechanism. If not, you’re left with the options presented herein. 

You’ll thank your future self for procuring a partnership agreement before you need it, and you can enlist a business advisor to help you create a bulletproof one.