This is part 3 in our series of tips for new business ventures and investments. In Tip 1, we discussed the disadvantages of using standard form documents. Tip 2 covered why you need an attorney to represent you individually instead of a single lawyer for the group of investors.
Tip 3 is more practical than legal. If you page through the form documents of your company, you will see pages devoted to topics of little relevance to the practical challenges that can face a new business. You might find two pages devoted to the requirements for properly noticing and conducting an annual meeting of shareholders and perhaps two sentences on what happens if the business needs more capital or faces a dispute among the owners.
It’s easy when a new and exciting investment opportunity comes along to see nothing but blue skies and high profits ahead. And no doubt optimism is an essential ingredient. But it is equally necessary, though frequently overlooked, to discuss the harder topics.
In that respect, people about to start a business are not that different than people about to get married. No one wants to talk with their soon to be spouse about all the reasons marriages fail when they could be daydreaming about the honeymoon. But the saying “an ounce of prevention is worth a pound of cure” is equally true in business planning. And there is much benefit to talking and planning for the hard issues before investing money and time in a new venture. We counsel many clients who have devoted years of toil and treasure to building up a company only to lose it to events that were foreseeable from the outset.
Before you decide to join a new venture, either with money or with sweat, consider talking through the tough topics below:
- Who is going to put in more capital in its needed and how much?
- Will owners grant personal guarantees of debt?
- Will the company get additional outside investors and if so, who will get diluted when we bring them in?
- Who will set the compensation for any owner also serving as an employee and who will approve raises and bonuses?
- How much of profits will get paid out in distributions and how much in bonuses and compensation?
- Will the business pay dividends or reinvest profits?
- What is the ultimate goal – sale of the business in whole or in part, income stream, and timing of those events.
- Does the company do business with an entity owned or controlled by one of the owners and how do we make sure those terms are fair?
- Is there a disproportionate share of power in the hands of a single shareholder and what protections and rights will each side have?
- Who will approve soft expenses like marketing and travel?
- What if someone wants to sell their interest?
- Will the company have employment contracts or non-compete agreements?
- What if someone needs to be fired?
- What is someone needs to be removed as an owner?
- What if someone wants to leave and start competing with the company?
- What will we do if there is a deadlock (assuming ownership levels could lead to such an outcome).
Not every question in this list applies to every business and many of these points may be covered by preparation of a thorough business plan. But the failure to discuss and address expectations on these points can lead to tension if not lawsuits, later on.
To the extent that these conversations can lead to productive agreements among the parties, many of those agreements can be documented in the company formation documents. Shareholder agreements, LLC operating agreements, and the like offer tremendous flexibility for memorializing the parties’ initial working relationship and plans in ways that reduce “he said, she said” disputes years later. But if merely having these discussions makes it clear the participants can’t agree on these issues when there is no tension and no one has anything at risk, then everyone has been spared a bad experience (and perhaps a lot of lost time and money) by walking away.