You need communication, cooperation and good organizational documents.
A promising company can have a one-of-a-kind product or service, a waiting list of customers and a string of investors eager to provide capital—and still end up a failure if its founders can’t get along.
During the early days of an emerging business, it’s easy to become excited while developing plans and strategies for a new product or service. There might not be as much enthusiasm for the possible drudgery of production, office work and financial management that follows.
Each party may have a different idea of what his or her role (and share of the profits) will be once the company is out of the startup phase.
That’s why expectations need to be managed and communicated as clearly and early as possible.
The Most Common Sources of Disagreement
Disagreements over work ethic and workload are probably the most frequent point of friction among business partners.
Although this is not to say one is good or another is worse, some founders are prepared to devote a substantial
portion of their waking hours to the company, while others may desire a more balanced lifestyle.
This isn’t the only area where founders can find themselves in conflict.
Sometimes the original concept for the company requires substantial modification once a product or service enters the marketplace. The enterprise may need to “pivot.” Some founders are flexible in this regard, and others want to proceed full speed ahead, “damn the torpedoes,” without regard to what the marketplace is telling them.
Some founders find the risks of an emerging company more disconcerting than others or simply need to assure themselves of a more secure stream of income. Consequently, their original commitment wanes—although they are unwilling to forsake or decrease their equity interests.
Future rounds of capital funding may require changes that some of the founders find unpalatable and, thus, impede attempts to raise the monies necessary to continue or grow the company. Anticipated issues, such as valuation and dilution, should be discussed in concept at the outset.
What Kinds of Legal Agreements Do Business Partners Need?
An entrepreneur and her or his legal counsel should use good business judgment to determine which documents are essential at the outset. For example, decisions to adopt a phantom unit plan or a unit appreciation rights plan for employees or third parties may be deferred. We do not want legal fees to overburden an enterprise from the outset.
Obviously, an operating agreement or its equivalent is necessary. This includes, among other things, the ownership rights and percentages, the management structure, authority for making distributions of profits, indemnification rights and the rights-of-first-refusal, as well as “tag-along” and “drag-along” rights of the members in the event of a sale. Sometimes, companies find it appropriate to actually enter employment agreements with certain of their members for a salary (guaranteed payment under an LLC for tax purposes), which can assist in defining their duties and responsibilities.
Confidentiality, noncompetition and nonsolicitation agreements are essential because it is very likely that at least some of the original founders will depart the organization or seek alternative sources of income. Of course, in order for these to be effective, the definition of the “business” of the company should be clearly described. This is one of the most common omissions.
In addition, founders often forget to actually enter into agreements to transfer the intellectual property they own to the company. This should be addressed at the outset for a variety of reasons.
How Often Should Agreements Be Revisited?
Depending on where a company is in its life cycle, its organizational and operational documents should be reviewed at least annually.
Although LLCs are not required to hold annual meetings, they are often a good idea. They provide an opportunity for the founders to review where they stand and to discuss future plans, such as funding requirements, implementation of incentive plans, marketing strategies, vendor agreements and the like.
The Key to All Successful Partnerships
Communication is absolutely the name of the game. A company’s principals should try to meet at the beginning of each week. This helps ensure that everyone is pulling on an oar and that they are in sync with each other.
No legal document is a substitute for regular communication among the owners. Attorneys can help clearly define the respective responsibilities of the principals, but the success or failure of a company will often turn on the owners’ ability to collaborate effectively.