Many of you have great ideas and dream of being your own boss — I am one of you.
About a year ago, I traded in my position as a partner in one of Seattle’s larger downtown law firms in exchange for being my own boss at a firm that I started. Since I am the only boss, my situation is fairly simple: Any arguments and disagreements I have are between me, myself and I, and I usually prevail.
However, for those of you who enter into business with a friend, a loved one, perhaps even a spouse, what is the single-most important agreement you should make before you contribute more than a minimum amount of money toward the joint endeavor? Depending on your entity of choice, it is the Operating Agreement for a Limited Liability Company, Partnership Agreement for a Partnership or Shareholder Agreement, alternatively referred to as Buy-Sell for a Corporation, including an S-corporation.
But why is the agreement among the parties who are owners/founders in your business so important? Because it deals with all the uncomfortable issues that most people don’t want to discuss. It’s rude to ask someone how much money they can contribute, how many hours they plan to work or whether to hire an office manager. Unfortunately, it doesn’t usually work that way.
Issues to consider
The agreement is important because it will force you to think about and discuss the following issues:
•What contributions will each person make, whether it is financial or in form of know-how, services or similar;
•How will decisions be made? Depending on the ownership structure, will decisions require unanimous consent, super-majority or simple majority, can one owner deadlock the business by refusing to cooperate, and if that happens, how will it be resolved: Should there be forced mediation or arbitration, or should a final vote be cast by an independent third party?
•Who will decide day-to-day operations: Will they be delegated to one person, or will all owners always be “in the kitchen” at the same time?
•If a corporation, how will the board of directors be chosen?
•What happens if an owner goes through a divorce: Does the former spouse have a right to 50 percent of the divorcing owner’s interest?
•Process for distribution of profits — Depending on the entity form, this will come in form of salary or distribution. It is important to discuss tax treatment of the various entities before deciding which entity to choose.
S-corporations, partnerships and limited-liability companies treated as partnerships for tax purposes are considered flow-through entities, and as long as the business is profitable, all profit are allocated to the owners and tax must be paid on the amount allocated, regardless of whether the money is actually distributed. Can each owner afford to pay the tax?
•Who determines the salary or distribution: Are there provisions for tax distributions (to cover the tax payments due)?
•How much vacation and long-term leave (including maternity, paternity and disability) can an owner take?
•If one owner wants to sell, does the other owner(s) have a right of first refusal, or can the owner sell to anyone?
The list is not exhaustive, but rather meant to show why it is so important to negotiate this Agreement before you are no longer answering each other’s emails or phone calls.
Court shouldn’t be an option
I have been involved in several situations where the parties did not have an Agreements — some were able to work it out; others, not.
A lot of people believe that our courts system will resolve these issues for them; those people have either never been in a lawsuit, or they have so much money that it doesn’t matter. Going to court is incredibly expensive and have been known to bankrupt many parties. In addition, it is often not satisfactory to either party, and it is a lengthy process, often months or years before a case comes in front of judge. During that time, you will still need to deal with your business partners and pay your lawyer.
By making sure there is an enforceable Agreement from the beginning, you may save yourself money, stress and time later on.
MONICA LANGFELDT is founding partner at Langfeldt Law (www.langfeldtlaw.com).
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