By Don P. Foster You and your brother, sister, neighbor, best friend, college roommate, internet chat buddy or some combination of all of the above develop a great idea for a business and decide to become “partners”. You have a great idea, are all going to work hard and make a lot of money. One of you is a self-professed “idea” person, another is a good “people” person, another is good with math; some of you have money, others a knack for working hard, and all of you are driven to succeed. The allocation of responsibilities is easy. It will trend to each of your particular talents. The product or service is novel, and you perceive your combination of skills and imagination to be unique. Can’t miss, right? Wrong. In addition to the predictable uncertainty of succeeding in any business venture in a competitive market, there is the predictable certainty that you and your partners are not going to always see eye to eye on how to run the business, how to distribute revenues (whether or not there is a profit) or how and when to sell all or part of the business, to name but a few of the most common differences that crop up between partners in small businesses. The shared vision that you thought each of you had when starting the business might change, or you might find out after the fact that one of you had an early exit strategy while others of you considered the business to be a career. Unfortunately, in the warm optimistic glow of starting out in business, partners too often ignore the potential pitfalls associated with disagreements between partners and fail to prepare a carefully thought out Shareholder, Operating, Partnership or Management Agreement, depending upon the legal form of the business, which identifies the partners’ respective ownership interests, quantifies the value of “sweat equity” versus financial equity, identifies management responsibilities, addresses the sale of part or all of the business and defines how disputes are to be resolved. These issues are not easy to address at the outset, particularly if the partners have not worked previously in the business world, or have not done so in partnership with others. It is much like the couple in love and getting ready to marry who find it difficult to discuss a premarital agreement in the event they get divorced. Although there are form agreements available on line, see, e.g., the form Operating Agreement for a Limited Liability Company available at www.entrepreneur.com, nothing can really take the place of consulting experienced counsel. Even if it is a brief one hour consultation an attorney will be able to identify the potential problem areas that should be addressed in a written agreement. So, the first rule that the new business partners should follow is to have a formal written document that puts down in writing how they expect the business to run and who is going to run it. The second rule is that if you are going to consult an attorney, try to make sure it is an attorney who does not have loyalties to one or more of the partners that supersede that attorney’s loyalty to the others, or to the business. You get what you pay for, so the college roommate of one of your partners who agrees to draft an Agreement gratis, is not going to address the issues with the same care that an independent, compensated attorney will, and could well be inclined to skew the management and profit sharing provisions of an agreement in favor of his or her friend. Many a good, profitable and viable business has broken apart on the shoals of a lawsuit after things break down between the former best friend/business partners, they have failed to provide for an inexpensive dispute resolution mechanism in an Operating Agreement (assuming for the moment that the business is a Limited Liability Company) and litigation is the only means left short of one side capitulating. Litigation is the high cost dispute resolution mechanism, which provides the party with the deeper pockets enormous leverage. A non-exclusive checklist of items to consider is:
- How are the capital accounts of the partners going to be credited in the event that there is an unequal distribution of actual invested capital and workload (i.e. “sweat equity”);
- How are partners to be paid in the absence of profits, if at all, and how will profits be allocated?
- How is management to be allocated, and how will disagreements be resolved? So, for instance if there are two 50/50 partners, will there be a third, non-equity partner included in a management committee to break ties?
- In the event additional capital is required, how will new investors be treated?
- Will there be restrictions on the right of an owner to sell, and will there be first refusal rights? How will ownership interests be valued in the event of such a sale?
- In the event of a stalemate, how will disputes be resolved? Possibilities include some combination of inter-personal consultation, mediation, binding arbitration or mandatory buy-sale.
This is hardly an exhaustive checklist. The prospective business partners should discuss the many elements of an Agreement with counsel. The important point raised here is that you need to consider these kinds of things, and put them in writing. Once you do, you can then set about doing what you really want to do…run a business and make money.
About Don Foster
Don Foster serves as the Chair of Offit Kurman’s Business Litigation Practice Group. He is a seasoned commercial litigator with a proven track record in the courtroom, which includes trying cases to verdict in federal and state courts throughout the country. He can be reached at firstname.lastname@example.org or 267.338.1357
About Offit Kurman
To learn more about Offit Kurman – one of the fastest-growing, full-service law firms in the mid-Atlantic region – please fill out our contact form. With over 100 attorneys in seven offices serving Washington DC, Baltimore, Philadelphia, Wilmington and Northern Virginia, the firm is well positioned to meet the legal needs of dynamic businesses and the people who own and operate them. You can also connect with Offit Kurman via Facebook, Twitter, Google+, YouTube, and LinkedIn.