Does your business have a legal structure in place that works to guide ownership through times of success and hardship? 

Key Issues

Whether it’s a partnership agreement, corporate shareholders’ agreement or a limited liability company operating agreement, the agreement between the parties should address issues relating to succession of control and ownership; delegation of management; relationship with key employees; critical decision making; dispute resolution; assignment or sale of the business; resignation, disability or termination of a principal; valuation; drag along or tag along rights; financing; and exit strategies.

The lack of planning in such areas usually comes to the surface in the event of success, selling or bringing in equity. Parties are rarely on the same page in relationship to how these matters should be handled. Alternatively, if the business struggles, it is increasingly hard to determine the path if the agreement fails to mention such instances. In a worst-case scenario, how do the parties work together through a dissolution or liquidation without a proper, formalized agreement? Many times, litigations have arisen due to planning failures associated with these crucial issues.

If you are an entrepreneur, it is never too late to examine these issues. The assistance of a lawyer results in drafting an agreement that assumes the best and the worst possible outcomes while setting up a strategy and procedure to deal with either result. These concepts are best dealt with while the parties are still in the initial planning stages; however, it can be hard to get people to focus on a plan that contemplates failure when the ultimate goal is success.

If the business has launched, or even if there is perceived trouble, it is not too late to sit down and map out what is to happen in the event of various contingencies, both negative and positive.

Types Of Agreements

The concept of an organic structural agreement is something that can be approached at any point in the life of the business.  First, you should establish what form of entity the business is operating under. That determines the type of agreement that is needed: partnership agreement (for a general or limited partnership); shareholders agreement (for a corporation, either an S corp or a C Corp); or operating agreement (for a limited liability company). Additionally, two or more people in business together who have not formed a business entity will most likely be treated as a general partnership.

The legal structure can be adapted to fit the business and personal preferences. It is smart to start with the basic components of the business: Who runs the business? How are responsibilities allocated? How are decisions made? Is everyone happy with these arrangements?

These principals should ultimately define how these matters are to be handled. This means the process of defining, in writing, how the business is going to work ends up defining how things will be changed in attempt to operate more fairly and efficiently.

In some cases, businesses allocate decision-making by responsibility: one person makes supply and vendor decisions, another makes personnel decisions, yet another makes financial decisions. Most would agree that this is more efficient than having everyone involved in every decision; however, some have trouble delegating any element of control.

Agreement Enforcement

The level of trust among the principals will be crucial in determining how effectively and efficiently this agreement will operate. The principals should imagine every major decision that may have to be made, such as firing a major participant or selling the business. They should also consider the method in which these decisions are going to be made. No matter how sensible you feel a particular approach may be, it will not work if one or more of the principals does not fully buy into it. The principals must have a way to compromise on a system of management that accounts for decision making in all areas. This system will ultimately be reflected in the agreement that is executed.

A closely-held business is likely a large, important aspect to a family and due to human nature, it is common for members to fight. There is a likelihood that there will be controversies and disputes. Although most of these issues will be resolved informally, an agreement needs to deal with disputes in the event that they cannot be resolved. Such obligations of the principals should be defined as precisely as possible. Common disputes arise over money or a lack of fulfilling the agreed upon obligations. The person creating the agreement should try to craft a mechanism that is suitable for the parties involved, ultimately allowing for parties to be put on notice when it concerns unacceptable performance or behavior.

Money Motivations

Last, but not least, there’s money. Concerns about money lie at the bottom of most motivations that drive a small business. The agreement needs to clearly define the responsibilities, obligations and rights associated with each party in respect to what is being contributed, what is being earned and what is being returned. The parties should agree on exactly what everyone’s share of any financial calculation is and if the actual numbers cannot be known, as is frequently the case, then a formula needs to be developed. Your agreement should contemplate such events as the death or retirement of a principal and the financial considerations to be addressed.

In Conclusion

Everything comes to an end and someday your business will be closed, sold or passed on to new leadership. The agreement needs to address such events and define how those events will ultimately take place. It is important for the agreement to anticipate developments and not leave it up to the emotions of the moment to decide what happens.

There are many components to consider, and this process can be quite difficult to handle while you’re trying to launch a business. But, taking the time to plan now proves a lasting benefit, as there will be less worry about the future when it happens to become the present.

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