Small Business

A Partner in Name Only


By karen E. Klein Q: One of the partners of our corporation has been inactive for some time. He is passive and does not contribute in any way. This partner does not want to be bought out, because he hopes that one day the company will do well and he will reap the rewards. We want to rebuild the company, but we hate to see this uncooperative partner benefit from our hard work. What should we do? -- B.P., Houston

A: A recalcitrant partner can be a big problem, so you're right to address the situation now, rather than sweep it under the rug. "The last thing you need is inactivity and ignoring the problem. It's like cancer -- catch it early and treat it with all you can muster," advises Bill Peterson, of W.R. Peterson Investment Banking of Kent Island, Md.

The bad news is that, short of drastic formal action to dissolve the corporation, which may or may not be an option for you, your working shareholders probably have no legal right to displace the inactive colleague, says attorney Mark Terman, of the Los Angeles law firm of Reish Luftman McDaniel & Reicher. Talk to your corporate attorney and clarify several details.

First, what kind of corporation have you established? This is vital because the specific nature of the entity may define your options in this situation.

Second, the state of incorporation makes a difference, Peterson says. "Texas may be a long way, legally, from Delaware. What are your incorporation state laws? Obtain appropriate counsel on these questions and be sure to make it clear that the legal fees will be the responsibility of all the shareholders, so the company can resolve this matter for everyone's benefit," explains Terman. "This could be enough to make the recalcitrant partner get real."

WHAT'S EXPECTED. If the reluctant partner will not sell his interest in the outfit, one option for rebuilding would be to recapitalize under new management rules, Peterson says. "Make him equally responsible for payments and repayments, and make him a participant in any collateral used to secure the note," he advises. "Make it clear to him that the lender is going to require a restructuring that facilitates active management, payments, and foreclosure should it come to that. Maybe these potential painful experiences will be enough to get his attention. Otherwise, play hardball now, because it will ultimately come to that anyway."

A more negotiation-oriented possibility would be to hire a professional adviser -- attorney, CPA, or reorganization consultant -- whom everyone in the corporation trusts. "The adviser can point out that the working shareholders should not resent the inactive shareholder, since he is probably a founder who put the company on the map in the first place," Terman says.

"The adviser can also point out that the inactive shareholder has no market for his stock," he continues, "and will probably never turn his past efforts into meaningful cash unless there are real incentives for the working shareholders to grow the business instead of leaving to possibly compete against it." Best of luck! Have a question about running your business? Ask our small-business experts. Send us an e-mail at smartanswers@businessweek.com, or write to Smart Answers, BW Online, 46th Floor, 1221 Avenue of the Americas, New York, NY 10020. Please include your real name and phone number in case we need more information; only your initials and city will be printed. Because of the volume of mail, we won't be able to respond to all questions personally.


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