Multi-Owner Businesses: Formalizing Owner and Employee Relationships

by | May 28, 2016

We often have clients who are in business with others – commonly called “partnerships” even though they are more likely “members” or “shareholders” than partners — where all the partners are working in the business. The elephant in the room for many of these partnerships is whether the relationship will work and what happens if it doesn’t; yet most of these companies don’t spend the time needed to really define – and document — what is expected from each partner and how they want to handle disputes. I understand why this is the case as individuals are entering into a partnership, they don’t want to talk about the what ifs or come across as the negative Nellie. Like a marriage, though, these relationships will have bumps in the road and the more you know about one another and have some clear rules of engagement, the more likely you will be successful.

When we started our restaurants, our company attorney insisted on setting clear rules of engagement between the partners, specifically the separation of ownership and employment in the company. When people go into business together, they generally don’t think this way but there are significant differences between an owner and an employee, even when they are the same people.

As an owner, you have a right to profit and loss of the company as well as to make certain limited decisions regarding governance and operations. These rules are set into the law but can be modified, to some extent, by an agreement between the parties. It’s commonly called a Partnership Agreement but technically it’s an Operating Agreement for an LLC, a Shareholder Agreement for a corporation, and a Partnership Agreement for a partnership. It can also be called a Buy-Sell Agreement. These agreements (we’ll call them Owner Agreements) describe how the company is governed and, more specifically, how ownership is transferred or repurchased in the case of death, disability, voluntary withdrawal – and even failure to perform duties to the company. Without these provisions, an owner cannot be fired, terminated or kicked-out. The owner’s rights to participate as an owner and its profit and loss rights remain so long as the owner is not breaching a duty of loyalty or care to the company (i.e. acting against its best interests, committing fraud).

On the flip side, an employee can be terminated under certain circumstances. Generally, employment is at-will; however, with owner-employees, we often put in place an agreement that the individual can only be terminated ‘for cause’; so that in an owner dispute, someone cannot simply be terminated at the whim of an angry partner. By putting in place some sort of employment agreement, you can describe the duties an owner is to perform within the business as well as set expectations about the employment relationship. I use the term “employee” here; however, I refer to an owner who also actively works in the business, regardless of whether the individual is paid or set up as a W-2 employee. Any owner who is expected to work in the business falls into this discussion.

There are a number of tools that can be used to address these separate but connected concepts. The duties and expectations can be a part of an Owner Agreement that describes the circumstances around how an owner is bought out if he or she fails to perform or can be in an Employment Agreement that triggers a buyout under an Owner Agreement if the owner-employee is terminated. Regardless of how you formalize it, having the discussions early and putting it in writing will alleviate many pains later on if a conflict arises.