Why You Need Written Agreements With Your Business Partners
Updated: February 20, 2020
What type of written agreement do I need?
If you have a business partner, you need a written agreement. The written agreement identifies who owns the business, each owner’s proportionate ownership, and some basic ground rules regarding operation of the business. The type of agreement depends upon the type of business.
- Shareholder’s Agreement (for corporations)
- Partnership Agreement (for partnerships)
- Operating Agreement (for limited liability corporations)
Though used for different types of business organizations (corporation, partnership, or LLC), these agreement are very similar in nature and purpose.
What should an agreement contain? At the very least, any written agreement between partners should:
- Identify who owns the business (this isn’t always obvious!)
- Identify each owner’s percentage ownership
- Describe how owners can join or exit the business
- Describe important accounting and tax provisions relevant to the business
- Identify how the daily business operations will be managed
- Identify who can vote, how to vote, and how much weight each vote carries
- Describe procedures to settling agreements between owners
- Describe any limitations on owners operating competing businesses
We’re Friends. Why Do We Need an Agreement?
You should have a great personal and working relationship with your fellow business owners. This does not mean you can skip the ownership agreement. Eventually, there will be a disagreement between the owners and it may cause such a divide that best possible resolution is for an owner to sell its ownership interest. If you agreement does not specify how to buy out another owner, everyone will be involved in a lengthy, expensive legal battle.
An agreement can protect minority interests with special provisions that require the minority owners’ approval before certain business actions can occur. Likewise, an agreement can protect majority interests with “drag along” provisions that compel minority owners to sell its ownership interest when the majority owners want to accept a third party offer to buy the business.
At some point, an owner will want to sell its interest (retirement, disagreement, moving out of the area, etc.). Do the remaining owners get first dibs at the sale? How is the price determined? These are important situations to be addressed by your agreement.
An agreement can protect the owners from personal liability if the business is sued or compelled to pay fines or settlements.
Even if the business has only one owner, a ownership agreement (here, either an LLC Operating Agreement or a Shareholder Agreement (for a corporation)) is one of the several steps used to separate the owner’s personal assets from the business assets.
The Pitfalls of the DIY Agreement
Though agreements generally contain the same basic terms, each business and group of owners is unique and each agreement will contain some unique provisions. For this reason, I do not advise copying an agreement from another business or using an online fill-in-the-blank template. A good business attorney will have an in-depth meeting with the owners to learn about the nature of the business, the industry, the owners and their relationships to each other, and the goals of each owner.
Lastly, when an attorney drafts an agreement, it is important the attorney and all the parties understand who is the client. Often, the client is the business and so the attorney is not representing the best interests of any one owner but is representing the to-be-formed business. Your attorney should have each owner sign a conflict of interest acknowledgement/waiver so everyone understands the potential risks.