Starting a business – at least the part which precedes the execution phase – is an exhilarating experience. Excitement abounds as hockey-stick shaped revenue projections migrate from the pages of the business plan into cocktail party chatter. And of course, the founding members of the business not only see eye-to-eye on all of the material issues affecting the company, but are in fact best friends for life.
The launch of any new business venture tends to put rose colored lenses over the eyes of the creators of the company. The real world, unfortunately, tends to set in rather quickly once the honeymoon phase is over. Minor disagreements between or among the founding partners often grow over time, sometimes reaching a point where these once-unified world beaters are no longer on speaking terms. It’s at this point that many a founder surreptitiously approaches legal counsel to find out what they can do to fix this untenable state of affairs. And more often than not, when said legal counsel learns that said founder failed to anticipate and work through any of said issues at the outset, a rather discouraging message is delivered – you’re stuck.
So how does one avoid this mess? Let’s rewind back to the entity-creation phase:
- See a Lawyer. Bring in a mutually-agreeable attorney while everyone still has a smile on their face. That’s the right time to discuss both the good and the bad, and seek common ground on the litany of thorny issues which inevitably arise over time in growing a business.
- An Odd Board. While there are myriad management issues to consider in launching a new venture, at a minimum shoot for a board of directors (in a corporation) or managers (in a limited liability company) with an odd number of members. Deadlock between 50/50 founders can be deadly to a business, while 66% allows the train to keep chugging along. If the business has only 2 founders and there are no other trustworthy candidates available at that time, at least make a gentlemen’s agreement to expand the board at some point in the future when a third potential board member presents him- or herself.
- Buy-Sell. If you don’t know what these 2 words mean when so juxtaposed, ask an attorney. Buy/sell agreements can take many shapes and forms, but at the root of it, these arrangements typically provide a mechanism for equity owners to either (i) retrieve equity upon the death of a founder (and compensate the estate), or (ii) extricate themselves from one another if they find themselves locked in a cage match. Consider taking out insurance policies to fund obligations which may arise under these agreements. These aren’t the happiest of issues to consider during such heady days, but they may well be the most important.
- Discuss money. Just as you would in evaluating a potential spouse for marriage, try to gauge your future co-owner’s views on saving, spending and making money. Who’s going to fund the entity? How much money will we need to achieve profitability? Are all owners equally willing and able to invest the necessary funds to reach that point in time? If one founder expects the founder group to pony up $1 million during the course of year 1, it probably makes sense for the group to be made aware of this expectation.
- Sweat versus Cash. If one partner plans to give money and one plans to give time (a/k/a “sweat” in the world of equity), what happens if the time-partner decides he wants his time back? Does he give his 50% ownership stake in the company back as well? What if this individual decides he wants to walk away with both his time and his equity? Vesting equity, repurchase rights, options to purchase equity and various other methods exist for addressing just this type of situation. What’s important here is that everyone gets on the same page at the outset. A departed founder holding 50% of the equity in his or her former company can, in many instances, lead to the demise of the company.
These are but a few of many items to consider in creating an ownership structure which can promote both operating efficiency and peace among the founders. Check back from time to time for more.