When starting or growing a business many of us take on an ownership partner to bring on complementary capability, funding, or access to new markets. Yet, like a rock band, some of these relationships end quickly, some last for decades, and some crash and burn in fortune-crushing lawsuits, or lead to misguided solo projects.
Even if your band of owners is putting out the hits today, it’s important to put tools in place to protect your ownership relationships from creative differences that may lead to an epic breakup.
Wait, what are owner relationships?
Owner relationships are the relationships not only between multiple owners of a business – the “partners” – but also between the owners and the company. These relationships are partly governed by legal constructs and partly by contractual agreements. Insurance can help with additional protection from certain risks. All three key legal infrastructure tools apply here and all three should be used.
Like guitar, bass and drum trio bands, these legal tools can rock on their own, but are far better together.
What common risks do the businesses face due to owner relationships?
There are multiple circumstances where legal infrastructure can be used to protect you and your business from risks associated with the owners of the business.
- A common one is the loss of an owner who is critical to the business due to death, disability or voluntary departure. The departing owner will typically be bought out. This risk creates two areas of exposure: replacing the key person and paying for their buyout.
- Another risk is that an owner acts in a way that harms the business and a claim arises against the company and against that individual.
- A third risk is that a dispute arises between the owners and they must part ways or find a way to work together, both of which are difficult scenarios.
What legal infrastructure tools can you use to mitigate risk?
Like a good guitar, bass, and drum trio (say Nirvana), the legal infrastructure trio – the corporate documents (think Bylaws, Shareholder Agreement, or Operating Agreement), key insurance policies, and a limited liability entity structure can create multiple lines of defense to help mitigate risks associated with the owners of the business.
- Corporate Documents
Our “first line of defense” is contracts. For owner relationships, the contracts are the governing documents.
For a corporation, these are the Bylaws and Shareholder Agreement. A corporation is legally required to have Bylaws that describe the decision-making process of the corporation including the size and authority of the Board, the Officers and their authority, and the procedures for filling these roles. Both single owner entities and multi-owner entities are required to have these in place. A second contract for corporate shareholders is the Shareholder Agreement.
The Shareholder Agreement covers the rights and restrictions of owners of the corporation such as limitations on an owner’s right to transfer their shares and the rules that apply to buy an owner out in different scenarios such as voluntary departure, death, disability or divorce. It may also include other agreements among owners including tax allocation and payments, loans to and from shareholders, liability protection, restrictive covenants such as non-competes, and how disputes will be resolved. Most importantly, the governing documents provide the rules of engagement among owners, the tools to make decisions even when times are tough or they aren’t getting along.
For an LLC, both the governance and ownership procedures described above are handled in the Operating Agreement.
The Shareholder Agreement or Operating Agreement, as the case may be, is an essential tool in setting expectations and limiting risks for business owners – but these documents are not legally required and many businesses don’t have these in place. By having well thought out governing documents, you’ll have clear rules of engagement for management and ownership decisions and you’ll be prepared to address ownership changes and disputes when they arise and make quick decisions that minimize negative impacts to the business.
Our “second line of defense” is insurance. Insurance’s most valuable role in ownership relationships is to provide confidence and cash for business continuity if an owner dies or becomes disabled. Key Person, Life, or Disability insurance limit the operational disruption and provide funds for succession. Insurance plays another role in protecting the business from actions by an owner. Directors and Officers insurance or Errors and Omissions/Professional Liability insurance protect the business from a mistake made by an owner and insulate other owners from such claims. Insurance ties into the contracts referenced above by providing the company or the other shareholders funds to help keep the business going if a buyout must occur or a lawsuit arises against the company or an owner.
3. Entity Structure
Thirdly, the entity structure – with limited liability – is the most valuable tool an owner relies on. Many entrepreneurs would not go into business without the confidence that their personal assets are not at risk to creditors of the business. The limited liability is important for protection when there are multiple owners making decisions. Each owner can be confident that one bad decision does not put their personal assets at risk. However, this protection only exists, though, if the owners comply with legal requirements to maintain the “corporate veil”.
The corporate veil is the legal separation that exists between the entity and its owners. To maintain it, the owners must treat the business as separate from themselves individually. Business accounting must be clearly separated from personal accounting, business decision making must be formalized, and the owners must comply with the legal requirements of annual meetings and corporate maintenance. It can be difficult for a small business to think about their separate roles as Shareholder, Board Member and Officer or to not comingle personal and business activities; but the separation and formality is essential to maintain the liability protection offered by the limited liability entity.
Don’t let your business’ owner relationships become like a one-hit-wonder band.
Leveraging these legal infrastructure tools – the Shareholder Agreement or Operating Agreement, key insurance policies, and a limited liability entity structure, so you create strong relationships among owners and ensure the individual owners are protected from activities of the company and from one another. While others may have ownership issues bogging down their decision making, you will be able to grow together — or to separate — with confidence.
Rock the stage like a maga band with Equinox as your roadie
Like a band might do a collaboration with another artist…. Or like your business may tap into a managed services provider (MSP) for HR, accounting or IT to expand your capabilities, you can also tap into the power of law with Equinox.
Our fixed monthly cost, managed services (MSP) approach removes the barriers of costs, response time, and complexity so that every business can have the same strategic law advantages as the mega corps.
Unlike the mega attorneys, we bring a balance of strategic business and legal guidance. You set the priorities and the budget. Our team builds a personalized plan at a fixed monthly cost to best serve your legal priorities and needs.
Schedule a complimentary Business Health Assessment today with one of our rockstar attorneys.
Check out these great resources:
2. Is your business’ “corporate veil” vulnerable? – EQUINOX
5. The 10 Messiest Band Breakups – ROLLING STONE