Starting a new business is almost always accompanied by exuberance and optimism. Too often, new partners dedicate all their time and effort developing business plans, finding capital, and soliciting customers while overlooking important housekeeping matters that can avoid costly intra-company disputes. Here are five ways to avoid trouble in paradise.
Have a Written Operating Agreement
Regardless of whether you form an LLC, corporation, partnership or other entity, the owners should sign an agreement describing how the business will be managed, how profits will be distributed, and expeditious mechanisms for resolving disputes if the owners become deadlocked.
By far, the most common causes of disputes in closely-held businesses involve: (1) who gets to make decisions; (2) how the profits are distributed; and (3) transfers of interests to third-parties. Addressing these and other issues at the beginning of the relationship is critical. Each owner should retain his or her own attorney to review and negotiate the agreement. Avoid using template agreements found on the internet or hiring one attorney to draft the agreement for everyone. Hiring your own lawyer can save a tremendous amount of time and money if disputes arise later. In fact, most lawyers will avoid representing all the partners to avoid potential conflicts of interest.
Define How Invested Money Will Be Characterized and Repaid
Business owners often provide seed money to get their ventures off the ground. Defining how that money will be treated, i.e., whether it is a capital contribution or a loan is crucial. If seed money is to be treated as a loan, having a written promissory note spelling out the interest rate and repayment terms is hugely beneficial. The owners should also develop rules for raising additional capital from the owners and for addressing those occasions in which some owners have the ability to contribute additional capital when others do not.
Have Transparent Accounting Systems
Distrust between partners is a cancer that has killed too many good businesses. Problems often arise when one partner feels as if he or she is being kept in the dark about the company’s finances and operations. Ideally, each partner should be able to review the company’s bank statements, financial statements, and accounting systems without having to request that access from the other owner or owners. This does not mean all owners should have equal control over the bank accounts or check-writing authority, but there should be mechanisms in place to assure that all owners know what is happening in real time or as close to it as possible.
Consider Developing Written Job Duties
Sometimes the partners play an active role in the business and sometimes they act as “silent” partners. Whether and to what extent an owner is involved in the company’s day-to-day operations should be spelled out either in the company’s governing agreement or elsewhere. If an owner is to receive a salary and benefits in addition to his or her profits interest, the amount of the salary and benefits should be spelled out in writing and agreed upon at the outset.
Provide for the Unexpected
Decide how you will handle a buyout of a partner who becomes disabled and how you will pay the estate of a deceased partner. Investigate approaches to value your enterprise and select a valuation method that you can memorialize in the operating agreement. Also, consider having the business purchase life insurance on the partners as a means of paying the estate of a deceased partner.
Costly and unpleasant disputes can and do arise in even the best-managed businesses. However, memorializing the agreement between the partners at the commencement of the relationship can avoid ambiguities that lead to conflict and expensive litigation. It is almost always easier to have these negotiations with your business partners before the venture gets off the ground than afterwards when the company is operating and making money.
Experienced practitioners can spot unique areas of concern when forming a business with partners and develop forward-thinking solutions for addressing problems before they arise. Do not be penny-wise and pound foolish when starting a new business. Litigation can be costly in “corporate divorces” if the partners fail to document their agreements clearly at the beginning of their relationship.