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If a founder leaves a business and no written equity

agreement is in place, what...
If a founder leaves a business and no written equity agreement is in place, what rights does the departing founder have in an equity discussion? Is there a baseline assumption of ownership? What power do other founders or the departing founder have in this situation?
To be clearer, there existed several conceptual ownership models based roughly on contributions of effort, but no specific model was agreed to formally. One model was used to set ownership %s for tax reasons but all agreed it did not account for the case of a departing founder.
The founder was with the company for 2 years before leaving.
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3/9/2010
socrateaser
socrateaser, Attorney
Category: Business Law
Satisfied Customers: 40,064
Experience: Retired
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What type of legal entity, if any, is this company? (corp, LLC, LP, LLP, general partnership)

Can you prove your separate financial contributions, in amount and date of contribution?

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Customer reply replied 8 years ago
LLC
I didn't make much of a financial contribution, beyond working for the company for 2 years with significantly under-market compensation (earning sweat equity).

Under N.Y. LLC. LAW § 606, unless your operating agreement provides for the withdrawal of a member, then you cannot force the other members to provide you with any early withdrawal rights, unless you sue the force the dissolution of the entire LLC. To do that would require some grouds of malfeasance. Otherwise, the remaining members have the right to continue the business. They would also continue to owe you a proporational share of the profits, too.

Note: if your LLC was formed in a different jurisdiction, then the laws of that jurisdiction would control the rights of members as between each other. It's likely, however, that the law of the other jurisdiction would be similar to NY law on this issue.

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Customer reply replied 8 years ago
Thanks! I have a follow-up question (I'll add a bonus to the payment to compensate). There's no problem with the business continuing, but in the absence of a formal equity allocation agreement, is there a default amount of equity/profit sharing rights that are entitled to the departing partner? Would it be the % most recently allocated on a tax return?

Under N.Y. LLC. LAW § 503, the value of a member's financial contribution, divided by the total contributions of all members, determines the member's proportionate ownership interest. A tax return would be extremely strong evidence supporting respective member ownership interests -- because it's executed under penalty of perjury.

socrateaser
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Customer reply replied 8 years ago
Does this apply if the founders made no/minimal financial contributions (only sweat equity)?
I'm afraid so.
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Customer reply replied 8 years ago
The tax return would show vastly different percentages than the financial contributions. Would the split be based on the returns or on the financial contributions?

Without an operating agreement, there would be no justification for a different percentage level. It's possible that you could make an argument that the tax return represents an "agreement" between the members as to the relative ownership interests. A return is filed under penalty of perjury, so it would be extremely difficult to argue that what's presented to the IRS is false, because that means felony tax fraud and perjury under federal law.

There is also a doctrine of equitable estoppel, which holds that when a party relies to his or her detriment, upon the statements of another, the other party should be "estopped" from asserting a contrary position. So, I think that a court might be highly inclined to refuse any claims contradicting the tax returns.

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