First, let me say that I'm not talking about going into business with your spouse. Suffice it to say, if you're already in a successful marriage with your potential partner, then you've got a dispute resolution mechanism far superior to whatever I could put together. And if you don't, well, that's not my area of expertise.
I'm also not planning to cover minority owner situations where you or somebody else has a controlling interest, and the others are just "along for the ride." That's not to say that there aren't significant and important protections for both the controlling and minority owners that should be reflected in agreements governing this structure. But that's a topic for a whole other video.
What I want to talk about now are some things you should be considering if you're thinking about going into business with one or more other individuals, whether they be friends, relatives or acquaintances, where none of you will have the final say about what happens. The most important thing, of course, is to choose your partners wisely. However, even then, it is still critical to back that up with legal documentation that fosters good faith cooperation and, if necessary, provides for termination of the relationship on terms that are fair and with as little contention and ill will as possible.
As you no doubt figured out, the first major issue in joint business ventures is so-called "corporate governance." How will decisions be made? You have probably already talked about this. Maybe one of you is going to handle sales, another might be responsible for production, and maybe other owners will take care of personnel, or finances, or other parts of the business. Or maybe all of you are going to work together on everything. Nothing wrong with any of this, but you need to ask yourself the question: What happens when you disagree? What if the person in charge of sales wants to hire a new salesman, and the finance person thinks the company can't afford it?
Two Person Firm Decisions:
If there are only two of you, your legal structures for decision-making boil down into roughly two categories, the "stalemate," where nothing happens unless both of you agree, and the "free-for-all," where each of you can do pretty much whatever you want, as long as your equal partner doesn't get too upset.
Three or more owners can give rise to more complicated legal structures. Majority rule is always a possibility. I think Winston Churchill said it best when he declared that "Democracy is the worst form of government, except for the alternatives." Many other legal checks and balances are possible, and sometimes advisable. Lawyers like super-majority requirements, because they know how to draft them. However, before implementing any super-majority requirement, you should ask yourself the question: If more than half of us want to do something, is it okay for a smaller group to say "Tough, we won't let you." There is no legal structure that is perfect in all circumstances. The best that your lawyer can do is highlight the issues, suggest alternatives and help you and the other owners decide upon a governance structure that fosters good faith and reasonable decision-making.
Hiring & Firing
Speaking of decisions, what about hiring and firing? You might be comfortable saying that nobody can become a new owner unless all of you agree. The question that really puts this whole decision-making set of issues into perspective is firing. You need to ask yourself two questions: Can a majority of you fire an underperformer? Or as I've heard it stated: “Do I really have to put up with so-and-so for the rest of my life?” While you're struggling with that question, think about whether it would be okay or likely for the other owners to fire you. This doesn't have to be a big issue. There are a lot of owners in our law firm, for example, and I have never really worried about them firing me or vice versa. But I've worked with many of them for over 20 years, and I've even worked with the "youngsters" for 10 years or so. If you're starting a business, you don't have that luxury.
Questions Regarding Firing:
What if somebody is fired, or just wants to quit?
Are you going to buy him or her out?
And if so, for what price?
And on what terms?
This leads directly into the next question: What if somebody is fired, or just wants to quit? Are you going to buy him or her out? And if so, for what price? And on what terms? There may be different answers, depending upon whether the person quits or is fired, or dies or becomes disabled. Terms can be important. A large cash down payment can put undue strain on the continuing firm’s finances.
The big issue is price. This can range from book value, (which is usually on the low end, and is based on the net assets that are already in the business) up to many multiples of earnings, which has more of a "blue sky" component based on future earnings. There are also professional appraisers that can be hired to determine fair market value. These determinations, of course, become critical when you are the one that has to borrow the money to pay off a nonperforming partner from earnings that haven't come in the door yet. Or when your other owners have decided to fire you right after you've grown the business and trained other personnel to the point where you are no longer indispensable. Frankly, I think a workable and fair buyout procedure is a necessary component of any good corporate structure. Owners are going to be reluctant to fire or mistreat one of their own if he or she can always quit and get paid fair value. Conversely, each of you is going to be well-motivated to contribute if your best path to financial success is through the collaborative efforts of all of you.
Non-Compete Agreements & Property Ownership
One final issue that merits mention in this brief synopsis as it relates to non-compete agreements and property ownership. If somebody leaves or is fired, can they go ahead and compete with the company? Maybe there should be different answers here too, depending upon how the termination is coming about. Along those same lines, are there customer lists, trade secrets, confidential information, or contracts and other tangible and intangible property, that should be accounted for in the buyout price? Or that maybe could be used by both parties after departure? Here again, be sure to ask both questions. Would it be okay for another owner to walk out the door and call on the same customers? If not, what are you going to do if they fire you?
We have set up a lot of business legal structures, and have helped resolve problems in many, many more. I can say with certainty that the success of any business is much more dependent upon the good faith cooperation of the owners than anything else. It is the lawyer's job to assist you in working through all of the issues to come up with a legal structure that fosters, and doesn't undercut, that good faith cooperation.