by Mark L. Zyla, managing director of Acuitas, Inc., and Jessica Wood, a principal at Bodker, Ramsey, Andrews, Winograd & Wildstein, P.C.
So, you’re about to start a closely held business with your best friend (or a few friends). Congratulations! Before you get started, though, think pragmatically on the front end to avoid headaches at the back end.
Here are a few tips to ensure that you and your partners start out on the right foot.
1. Hire professionals.
You’ve probably heard that a person who represents himself has a fool for a client. Regardless of your knowledge base and skill set, you should delegate certain tasks to professionals who have emotional distance from your venture, and who can provide valuable tough love and advice as a result. For example, an attorney can assist with issues concerning corporate formation (such as the pros and cons of corporations, limited liability companies and other structures) that may impact liability. A CPA provides input on tax structure and metrics, and assists with due diligence related to your industry.
2. Think about your employee and ownership hats.
Must you wear both simultaneously? If you stop working for the company, how will that impact your voting and distribution rights? Are they separate or interdependent? You should also understand that you may be liable for certain acts or omissions as a manager, officer or director, but shielded from liability as a member (in a manager-managed LLC) or shareholder.
3. Anticipate disagreements.
Who is the decisionmaker? Will one shareholder (for a corporation) or member (for an LLC) make all or most of the decisions? Are there decisions that must be unanimous? If the company is owned 50/50, consider a tie-breaker provision that involves a third party. Consider the county of your registered agent for service of process and principal place of business, where you will be subject to lawsuit. Your attorney should be able to tell you about the jury pool and significant reported decisions from that venue. If you prefer a private arbitration that cannot be appealed, you can include an appropriate term in your employment, vendor and other contracts.
4. Envision your exit before you arrive.
If your company is owned 50/50, what happens if one person wants to leave? Is it prudent to have a set formula for valuation before you know how the company will perform or will you require the company to pay for an expert to value the company if one side wants to sell? And what if the parties cannot agree on that expert? For example, you can determine a term that requires shareholders to hire their own experts and then harmonize those numbers, or you could have a term that requires the members/shareholders to hire experts who then select a third expert to provide the valuation. You could also have a provision that gives both 50/50 owners a reciprocal right to buy out the other owner. And how will the purchase be funded? Lump sum at closing? Percentage ownership that is released over time with progress payments? Division of accounts receivable as collected?
5. There is no one-size-fits-all approach.
Businesses have their own culture, protocol and rules that are congruent with mission and values. What type of behavior do you want to incentivize or discourage in your contract drafting process (for shareholder or operating agreement, employment agreement, employee manual and vendor and service agreements)? Your message should be clear and consistent.
6. Ask tough questions.
It is heady and fun to start a new business, but be alert to magical thinking and the very human tendency to ignore obstacles. You need to ask questions and perform due diligence before you invest substantial time and money. Consider regular face-to-face meetings with prospective partners, so you can gauge body language and “listen between the lines.” Has your prospective business partner invested in or run a business before? Is there litigation history? Bankruptcy?
7. Who owes what?
Are individual owners going to personally guarantee any debt, such as a line of credit or lease? In other words, if the company defaults on a loan to the bank, can the bank sue the company or can it sue you individually (and conceivably come after your bank accounts, home and other assets)?
8. Protect your company’s customers, employees and intellectual property.
In a nightmare scenario, an employee can start up a competing company, and leave with customers, employees and intellectual property, demolishing everything you’ve worked hard to build. A properly drafted agreement can prevent that outcome. But see #1: Unless you have a knowledgeable attorney draft it, parts of your agreement may not be enforced, or the judge may have the power to “blue-pencil” certain terms.
And the value of having a trade secret non-disclosure is two-fold: It issues clear instructions to employees to use caution with regard to certain information and the existence of the agreement may be vital to proving that information deserves heightened protection.
9. Plan for your company’s eventual valuation.
You may have to eventually have a valuation of your company for a wide variety of reasons, ranging from a buy-out of your or your business partner’s interest to planning for your estate taxes. Proper planning for a valuation can make this process much smoother. Consider including the process for the valuation to be included in ownership agreements. Common provisions range from the inclusion of an agreed upon valuation multiples, such as a multiple of earnings, to the process for the retention of a valuation expert. The ownership agreement should discuss the various ownership percentages and the rights and privileges of each.
Lastly the term “value” should be clearly defined in the ownership agreements. For example, the term “fair market value” as opposed to “fair value” may have different meanings to valuation experts. Include the agreed upon definition of value in the ownership agreement.
Mark Zyla is a managing director of Acuitas, Inc., a valuation and litigation consultancy firm. He may be reached at (404) 898-1137 or firstname.lastname@example.org.
Jessica Wood is a principal at Bodker, Ramsey, Andrews, Winograd & Wildstein, P.C., a law firm focused on corporate, employment, estate and probate, family law, litigation, real estate and technology. She may be reached at (404) 564-7409 or email@example.com.