With our hearts set on a new brewery, Kevin and I enrolled in classes at the Small Business Development Center at the University of Wisconsin’s School of Business.Their equivalent today is the “BizSmart Training for Entrepreneurs” program, with classes one night each week for eight consecutive weeks.Each week touches on a broad topic of significance to a new business owner: marketing, taxes, financing, accounting and, legal issues, for example.
During our session on legal issues, we talked extensively about the various business structures that are available to entrepreneurs.We’ve discussed those here, too: operating as a sole proprietor, limited liability company, corporation, and partnership.Each has certain advantages, but most have one thing in common: a governing document, or agreement, that determines how the members, shareholders or partners, will run the company.
Kevin and I opted for a limited liability company, which we liked partly because of its ease of management and the protection it provides from liability.Setting up an LLC with the State of Wisconsin is a pretty simple thing, but beyond the initial setup are a variety of filings and documents that benefit from more detailed attention and professional advice.The big one is the Operating Agreement, sometimes called a Membership Agreement.Partnerships and corporations have similar governing documents: Partnership Agreements and Bylaws.They all serve the same general purposes: to establish how the company will be operated, how the respective ownership interests will be valued, and how the company will eventually dissolve and wrap up business.
I can’t say this plainly enough:if your new business has two or more owners, you’re crazy not to have an operating agreement. Moreover, the complexity of an operating agreement almost certainly justifies an attorney’s involvement.Sure, there’s an expense tied to that, but the cost pales in comparison to the costs of a messy business breakup. That won’t be an obvious concern at the start, when the excitement of the idea and its potential can blind you to the potential conflicts that lay ahead.But just like good fences make good neighbors, a good operating agreement can help secure a good working relationship, and an otherwise successful business when the relationships go bad.
Truthfully, that working relationship is going to be tested somewhere along the way. You’re going to spend a lot of time with this person – probably more than with your family.Personality quirks will become annoying.Creative differences will take on greater weight.Communication will become strained. Ultimately, the problems come to every business – sometimes because the business struggles and sometimes because it succeeds; sometimes just because people and circumstances change.Eventually, even the best communication and willingness to compromise can be inadequate guards against the stress and pressure of running a business together.
Where compromise isn’t possible, an operating agreement can establish how decisions get made.Sometimes one member gets management rights, making day-to-day decisions easier.When there is no manager, tie-breaking procedures can be established well before a disagreement occurs.Arbitration provisions can address more complex disagreements.Even with all those provisions in place, a lot of business relationships, so successful at the start, eventually come to a bitter end.That’s where the business agreement really earns its keep. If a partner wants to be bought out, the agreement determines when that can happen, and how the purchase price is established.It ensures that the business itself, or its other members, have first right to purchase the outgoing member’s interest.If that fails, an agreement determines who outside the company can acquire an existing partner’s interest, and who can’t.
Business agreements aren’t just about the bad times, though.They also serve to define the various ownership interests.That’s important if you plan on bringing in other investors somewhere along the way.Kevin and I did, and our Operating Agreement allowed others to secure a financial interest in the company without our giving up management rights.Sometimes these terms need to be ironed out with your investors, but the beauty of an Operating Agreement is that it can be amended from time to time, making that possible.
In short, a business agreement offers a framework in which to get your business started, and the flexibility to change as the business changes.Also, it anticipates the rough times ahead, even when it’s tough to imagine rough times, and provides a means of working through those rough times as easily as possible.Remember: it’s before the rough times, right at the start, when agreement is easiest, that an agreement should take form.It’s an important first step to jointly running any business.
Lance A. McNaughton practices estate planning, probate, business, and real estate law in both Lafayette and Green Counties in Wisconsin. He can be reached by e-mail at mcnaughton@swwilaw.com.