Setting the ground rules

By Andrea Bradley

When going into business with two or more people.

When two or more people go into business together they are acknowledging that together they can achieve more than what they could have if they went into business on their own.

There is no doubt that when people first think of going into business together, there is usually lots of optimism and positive energy. What people rarely think about at this time is what happens when it ends?

The ending of a business relationship is as an important time as starting it. Endings can happen amicably (retirement, business sale) or not so amicably (disagreement, business failure). Businesses can end for reasons beyond your control (death or incapacity).

So what happens when a business comes to an end? Well the short answer is – it depends! One of the most important things that two or more people contemplating going into business together can do is invest time and effort into a partnership/shareholder/unit holder agreement.

So what are in these agreements? The agreements set out the ground rules. They usually address the key items such as:

• The type of business to be conducted
• How and what capital contributions are required and how profits are shared. It might also consider profit distribution and retention policies.
• How the business is managed. This might address matters of voting rights, casting votes, management roles, etc. What decisions need to be unanimous or only by simple majority.
• What happens when someone wants to get out of the business relationship, when someone dies or becomes incapacitated. This is documented to ensure there is certainty in the event of changed circumstances. These clauses will consider wind up or buy out options. It might address the need for cross partner insurances.
• How the business is valued. Again to provide certainty for when someone is exiting a business, or how a buy in or buy out price is determined.
• How new owners join. Rules around admission of a new business owner and deals with business succession.
• How the business is wound up. How are assets distributed. Can one business owner continue on.

Of course other issues can and are dealt with in these agreements. The true value of an agreement is that it provides certainty. Agreements are best drawn up at the beginning of the business relationship when everyone is thinking the same way. This means that potentially contentious issues are considered prior to the investment of time and assets into the venture. This is when people have less to lose and there is less chance for a vested interest to get in the way of the correct position.

So why doesn’t every business with arm’s length parties have an agreement? Often it is just overlooked, but just as often it is to avoid a cost at an early stage of the business. The cost of any dispute in the absence of a written agreement is usually substantially more than the cost of drafting up the original agreement. So our advice is to consider documenting your business arrangements at the outset of your business relationships.