First – congratulations! You not only have a business idea you are excited about, but you have someone else who wants to be in business with you. That’s great – we love entrepreneurs! Now, let’s talk about how you are going to make this business relationship a success:
- Is there a way to try doing business with each other on a short-term, less formal basis to see if it will work?
If the business idea is largely at the concept stage, it can be a good idea to give this new relationship a test run while you are refining the business idea. You can enter into a joint venture agreement, which specifies what each person is responsible for contributing and clarifies how you will exit the relationship if it isn’t working as intended. You can also create a framework for a more integrated relationship if it is successful. However, care needs to be taken to ensure that the business idea and each party’s contributions are protected, even if the business relationship does not work.
- If you are ready to jump in to a formal, long-lasting business relationship, what form should it take?
Often, a new business with more than one business owner is best structured as a corporation. Corporations can allow for easy structuring of different ownership interests (i.e. voting vs. non-voting shares, different percentages of ownership, and sale and transfer of ownership interests). Corporations can also provide protection from individual risk and can provide better tax treatment for income. If a corporate structure is adopted, then a shareholders' agreement is a necessity – this is the document that specifies the key points mentioned below.
In some cases, however, different business relationships are recommended. It may be that a simple business contract can document the relationship. A formal partnership might be the better way to organize the business. In other cases, existing businesses might be joining together and want to enter into a formal joint venture agreement.
No matter how the business relationship will be structured, a formal, written agreement of some sort is highly recommended. Business success is built on a foundation where the parties understand their roles, risks and responsibilities. Success is also, strangely, supported by a clear path to dissolve the business relationship: this helps ensure that the relationship can grow and evolve as needed, and allows for the most efficient way of dealing with the issues, which will inevitably arise.
Here are some of the key terms, which must be addressed in any business contract to best ensure the success of the relationship.
**It is important that all business partners get independent legal advice before these documents are signed, so that all participants understand the full implications of their individual roles, responsibilities and risks, in association with the business.**
- How are you going to end the relationship? Perhaps the most important consideration when starting a new business relationship is to decide how it will end. A business relationship is like any other relationship – you don’t want to talk about the end. Although it can be uncomfortable, it is absolutely necessary. There needs to be a clear path for how to leave the relationship or how to remove a business partner, if the relationship cannot continue. Consideration also has to be given to issues like non-competition and non-solicitation of employees and clients/customers. The more detailed the “termination” process is, the smoother the process will be (if it needs to happen). It also means less money spent on lawyers!
- What will the ownership structure of the business be? The 50:50 ownership structure is common when starting up a business relationship, but great care needs to be taken to reflect contribution (discussed in the next point) and risk undertaken by the different owners. One of the most dangerous ownership structures to have in a business is a 50:50 ownership with no business agreement to resolve conflict or to determine how owners will enter and leave the business (also discussed below). If the goal of the business is to ultimately sell it and profit from the growth of the company, then ownership should be structured with a view to this goal.
- What role does each party have in the business? Who is going to have active, day-to-day management of business decisions and which decisions require unanimous or majority decision-making. Having a clear definition of the role each party plays in the business, and revising that as the business evolves, is key to meeting business organization objectives. This can be addressed in the formal business documents, including a shareholders' agreement.
- How will each party be compensated? Having this discussion and having clear documentation of the agreement on compensation can remove a lot of tension in the business as it grows. Compensation based on contribution should be considered and it should be determined if there is there an objective way to measure that contribution. Compensation may also reflect the degree of risk that each party took in starting up the business – for example, if one party contributed more money or other assets at start-up, then they might have a different compensation reward system until that contribution is fully recognized. It needs to be decided if the business owners will take compensation in the way of salary, dividends of the profit of the business or otherwise. If the business is sales driven, a compensation structure which correctly recognizes sales as a driver of compensation is important; however, it must also have a way to recognize the non-sales business functions. Compensation structures do not need to be complicated, but they need to avoid situations where one business party is left feeling like they contribute more than other parties, and receive less or equal compensation. That situation will inevitably lead to conflict in the business relationship.
- How are you going to finance the business? Care needs to be taken to clearly outline the initial financing of the business as well as how to meet ongoing financing needs. Will future financing needs come in the way of shareholder loans to the business, or will it come by way of additional share ownership (which can disrupt the initial agreement on ownership structure)? How much of the business profits will be reinvested into growing the business and how will those decisions be made? Again, these details should be formalized in the documentation of the business.
- Are there existing business assets which need to be brought into the business? It is often the case that existing assets will be brought into a new business. Any business agreement needs to recognize the contribution of those assets and also, if relevant, deal with what will happen to those assets if the relationship ends. For example, if there is an existing business name and entity, what happens to it if the relationship ends – who has the right to have that name and entity?
- How are you going to bring new people into the relationship? As your business grows and changes, new business owners might be welcomed in. It is important to outline, in advance, how this will happen. For example, it is common to allow existing business owners to contribute additional resources and to take a larger ownership interest before new owners are invited in. This process can be documented in a shareholders' agreement.
- How are you going to deal with challenges and disagreements? A good business agreement will provide a process for resolving business disputes or disagreements. This can be an agreement on a mediation process with a third party. Having this process in place provides a way for owners with a smaller ownership interest to have their say in business decisions, and helps resolve the conflict prior to having to trigger the process to leave or remove another shareholder. In a corporation, a shareholders' agreement can provide the roadmap for resolving disagreements about the business, and allow for the entering and exiting of people involved. Without a shareholders' agreement, business owners not only waste valuable time resolving issues, time which would be better spent running their business, but they also, often, spend valuable dollars visiting their lawyer to resolve the issue.
Again – it is most important for all business parties to fully understand the agreement, which is being entered into. They need to understand what roles, responsibilities and risks they are taking on. Key to this understanding is obtaining independent legal advice. We can help explain the scenarios that will trigger certain events and manage your expectations of your business relationship. A new business relationship is an exciting thing, but it is important to take the leap with right protections in place!
How Momentum Can Help
Come in for a free, one-hour consultation on your business relationship. We will help you formulate a plan for your business relationship structuring and a roadmap for how to document it. We can also connect you with the other professionals you need to involve in your business to plan for success. Alternately, you can attend one of our Business Start-Up Boot Camp sessions to develop key skills for success and/or we can provide independent legal advice on the business structure you are entering into.