How RIAs Can Avoid Business Divorce

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For RIAs, starting a business with partners can be exciting and full of promise. You’re likely coming together with a shared vision, common goals, and high hopes for success. But as with any partnership, the road ahead may not always be smooth, and conflicts can arise. When these disputes aren’t handled properly, they can lead to something every business owner dreads: a business divorce.

Business divorces are often painful, expensive, and damaging – not just to the individuals involved, but to the advisory firm’s reputation and, most importantly, to its clients. However, with some foresight and planning, many of the common triggers for a business split can be avoided. One of the most effective ways to safeguard against a potential falling-out is by putting in place a clearly-drafted operating agreement. This foundational document can help prevent misunderstandings and provide a roadmap for resolving disputes before they spiral out of control.

Let’s take a closer look at how RIAs can avoid business divorces, and how a well-crafted agreement can serve as a powerful tool in keeping partnerships healthy and functional.

Upfront communication

The best time to prevent a business divorce is before it ever becomes an issue. One of the key reasons partnerships fail is because partners don’t take the time to outline each person’s roles, responsibilities, and expectations early on. When these details are left vague or assumed, miscommunication and unmet expectations can quickly lead to resentment.

A well-drafted operating agreement forces the partners to have important conversations upfront. These discussions may not always be comfortable, but they are critical. For example, how will decisions be made? Will there be equal voting rights, or will one partner have more authority in certain areas? What happens if one partner wants to take a step back from the business or decides to leave entirely? Having these conversations early – and documenting the results in a formal agreement – helps ensure everyone is on the same page from day one.

An agreement doesn’t just clarify roles and responsibilities; it also provides a framework for decision-making. Business partners won’t always agree, and that’s okay. What’s important is having a clear process for resolving disagreements. An operating agreement might specify that certain major decisions require unanimous consent, while day-to-day decisions can be made by a majority vote. Establishing these rules early on prevents confusion and frustration down the road when differing opinions inevitably arise.

Addressing ownership and compensation matters

Another critical area where partnerships often falter is around ownership and compensation. It’s essential to clearly define how much ownership each partner holds and how profits will be distributed. While this may seem straightforward, it can quickly become complicated, especially if one partner feels that their contributions are not being fairly compensated.

For RIAs, this could mean discussing how much each partner is contributing in terms of initial capital, business development, or client acquisition. Is one partner bringing in a majority of the clients while the other focuses on operations or compliance? Should these contributions be compensated differently, through salary, bonuses, or profit distributions?

Having an agreement that clearly spells out how partners will be compensated, both initially and over time, can prevent future disputes over money. The agreement should also address what happens if the advisory firm grows significantly or if a partner’s role evolves. For example, will ownership percentages adjust over time, or will they remain static? These are all critical discussions to have early, and the decisions should be documented in the agreement.

Addressing contingencies

No one likes to think about worst-case scenarios, but planning for them is essential to avoiding a business divorce. An operating agreement should include provisions for how to handle various contingencies – whether that’s one partner wanting to leave the business, a partner becoming incapacitated, or even the death of a partner.

For instance, the agreement might outline a buy-sell provision that dictates how ownership interests will be transferred if a partner exits the advisory firm. Will the remaining partners have the option to buy out the departing partner’s share, and if so, how will the value of the business be determined? These provisions are critical because they help prevent messy, emotional disputes during times of transition or uncertainty.

It’s also important to discuss what happens if one partner is not pulling their weight. Will there be a process for addressing underperformance? Can a partner be forced out of the advisory firm, and if so, under what circumstances? Establishing clear expectations for performance and consequences for failing to meet those expectations can prevent resentment from building over time.

Creating a path for growth or exit

Even if things are going well, it’s essential to plan for the future. This includes discussing both how the advisory firm will grow and how partners can exit the business if their goals change. Growth plans should be part of the overall partnership strategy, ensuring that all partners agree on the direction the advisory firm is heading. Are you planning to expand your service offerings, bring on new partners, or even merge with another firm down the road? These are important discussions to have, and they should be reflected in the agreement. For an article outlining a roadmap for succession, click here.

An operating agreement should also outline a clear exit strategy for partners. Life circumstances change, and one partner may decide they no longer want to be part of the advisory firm. Having a well-defined process for how a partner can exit, including how their share of the business will be valued and transferred, is key to avoiding a contentious split.

Many operating agreements include non-compete or non-solicitation clauses to protect the advisory firm if a partner leaves. These provisions can prevent a departing partner from taking clients with them or starting a competing business in the same area. However, it’s important to ensure these provisions are reasonable and enforceable. A non-compete that’s too broad or restrictive could lead to legal challenges, which is why it’s essential to have these clauses reviewed by an experienced attorney.

The role of professional advisors

One of the most practical steps RIAs can take to avoid a business divorce is to seek professional advice when drafting their operating agreement. Working with an attorney who specializes in business law, particularly within the financial services industry, can help ensure the agreement is comprehensive and tailored to the specific needs of the advisory firm.

Accountants and financial advisors can also play an important role in helping partners understand the financial implications of their decisions, including compensation structures, profit-sharing arrangements, and buy-sell provisions. Having a team of trusted advisors helps ensure that the agreement covers all the necessary bases and can stand the test of time.

Conclusion

Business divorces can be devastating, both personally and professionally, but many of the common causes of conflict can be avoided with the right planning. For RIAs, having a clearly drafted operating agreement is one of the most effective ways to prevent disputes and ensure the long-term success of the advisory firm. By addressing key issues like roles and responsibilities, ownership and compensation, and contingency planning upfront, RIAs can avoid many of the misunderstandings that lead to a business divorce. With clear communication, well-documented expectations, and the guidance of professional advisors, partners can build a strong foundation for a lasting and prosperous business relationship.

Richard Chen is a managing partner with Brightstar Law Group, a law firm that serves investment advisory firms by providing proactive business-minded solutions pertaining to corporate and securities-law-related matters. Among other things, our firm provides counsel with respect to securities and compliance matters (including representation in SEC examinations), private fund formation, corporate formation and structuring, business transactions (including M&A and joint ventures), contract drafting and negotiation, employment law matters, operational due diligence, and succession planning. For more information, please visit our website at www.brightstarlawgroup.com or call us at 917-838-7398.