Starting a business is an exciting time in your life. Your days are filled with meeting prospective investors and advisors, and you are eager to go live with your new product or service. But don’t overlook one of the most important decisions during this time: Who will you go into business with, and how can the risks of that relationship be managed? I’m not going to tell you who is or is not a good business partner. Instead, I’m going to highlight some issues to which you should give special consideration.
Whether your business partner is a good friend, significant other, family member, or former colleague, it is impossible to predict how that relationship will change over time. While no one wants to think that it may deteriorate, there are some fairly simple steps you can take at the outset to protect both you and your business partner(s) if it does.
- First, if you will have just two owners, avoid 50-50 ownership. This may be difficult for both owners to swallow, but having a majority owner (i.e., 51% or greater) simply makes things easier and avoids deadlocks (see below).
- Second, if the owners will be active in the business, each should have an employment agreement clearly setting forth his or her responsibilities and circumstances under which either the employee or the corporation may terminate the relationship. This can be done even if the employment is at-will. In a limited liability company (an LLC), members have member services agreements.
- Next, don’t go too far without a carefully-drafted buy-sell agreement (for a corporation) or operating agreement (for an LLC). A buy-sell or operating agreement addresses issues among owners, such as allocations of profits and losses, timing of distributions, and transfer or sale of ownership interests, but there is really no limit as to its contents. It may seem time-consuming to prepare, but it may help dodge disagreements or drawn-out negotiations upon the occurrence of certain events. For example, the agreement typically provides that the company, first, and the remaining owners, second, have a right of first refusal to purchase another owner’s interests upon his or her (i) proposed voluntary transfer to a third party, (ii) death, (iii) disability, (iv) termination of employment, or (v) involuntary transfer (i.e., bankruptcy or divorce). It provides how the purchase price will be determined and paid. It may also set forth conditions under which an owner may be expelled.
(or “Texas shootout”) provision may also be desirable. Deadlock
provisions provide for the resolution of a stalemate, typically by a neutral
third party. A put-call allows one owner (the “Offeror”) to offer his or
her shares for sale to the other owner (the “Offeree”). The Offeree has
to either accept the Offeror’s offer or sell his or her shares to the Offeror
on the same terms. Because the put-call may be invoked at any time
during the entity’s existence, some two-owner entities forego it. However,
it is perhaps the most effective way of determining how an owner may
be bought out, thereby circumventing long and expensive legal negotiations.
Of course, not all issues can be anticipated or prevented. Before starting a business, you’ll want to seek the advice of an accountant and attorney on type of entity, ownership structure, and other matters. A little extra time and money at the outset can avoid major problems down the road.
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