Taking on partners and investors in your business can reap rewards in terms of knowledge, finance and even emotional support, but getting the right partner is only one element of a successful partnership. A prudent entrepreneur will always formalise a business relationship in writing.
Why ? Because when problems arise (and problems will arise), having a written well prepared agreement to fall back on will save you untold hardship.
Beware the Honeymoon Phase
In the beginning, there is excitement, a great idea and a new business, all is rosy, savings are invested and loan finance is approved. Everything is set for the money to roll in, but wait ! It’s three months in and cracks appear, sales are slow to take off, creditors are leaning on you for payment you you’re finding it tough to pay the office rent. A promised sale has fallen through and it slowly dawns that you expectations have exceeded real sales.
What happens now is that the business owners must step in and take responsibility under circumstances of greets stress, trodden expectations and financial difficulty. A written agreement under these circumstances is a God send – it will provide for how disputes are to be resolved, who is responsible for capital shortfall and what steps should be taken and by whom and how and when they will be implemented.
The Shareholders Agreement
The agreement can take the form of a “shareholders agreement” for a limited company or a partnership agreement or business owners agreement for a non corporate structure. The agreement will also cover more than just disputes – it will govern the general relationships between the business owners and include provision for the management of the company, directors duties and responsibilities, ownership and profit sharing.
In addition, the agreement will, make provision for one partner buying out another (to include for example, the right of first refusal and an agreed formula for share valuation). it should also set out procedures and valuation methods to be used in the event that the business is sold or a lucrative approach was made from a prospective purchaser.
The agreement will also record the financial contributions of each to the business which will be useful in the event of an exit by one or all of the partners and it should also provide for how the business should be wound up and under what circumstances a winding up will be possible.
The following are some of the issues which each of you need to begin thinking about before preparing the agreement:-
- Who is contributing what towards the capital of the business ?
- How are loans relating to the business going to be serviced ?In the event of death or bankruptcy or one partner leaving should this trigger the sale of the business or should a right to purchase apply ?
- In Event of a sale or buyout, how will the pre-emption rights operate ? By what criteria is the business to be valued ?
- How will the net proceeds be divided between co owners ?Is there a “sweat equity” partner ? (eg. provision for someone who may not put in as much money but takes responsibility for the running/letting/management of the property)
Even if you are past the start up stage it’s never too late to propose that the business owners sign up to an agreement but put it in place when times are good.