Three individuals decide to start a business. They have a unique service to offer and there is a proven need for their service. The three founders combine talents and personalities that would be near impossible to replicate. They have put together an extraordinary business plan that demonstrates their attention to detail and ability to plan ahead.
The founders have followed the plan and each is financially invested to the tune of five figures, which was part of the plan. Their beautiful website is almost complete and will launch within weeks along with other web marketing tools, but they forgot two things: the operating agreement and buy-sell agreement. These documents essentially determine how the members will behave and how ownership is permitted to change. It is strongly advised to get these things in order as early on as feasible and preferably before each founder is in five figures deep.
Why is an operating agreement so important?
In short, it establishes basic guidelines by which a business will operate and make changes. For example, is a majority vote or can changes to the business only be implemented through a unanimous vote? Without forethought and agreement the result can be deadlock and result in no action, which is often the worst kind of action.
According to the website of one wealth management firm, “The simple truth is, emotions matter when it comes to financial decisions.” Establishing a buy-sell agreement early in the development of a new business is a good way to set out a plan of action in a rational way. This allows for there to be a plan of action for any situation that may arise in a business’ day-to-day operations.
At what point do the members begin getting paid?
How much and when? In the case of our theoretical business the owners were so excited to make money and calculate the revenue opportunity that they failed to consider what they would do with it. They all agreed that in the beginning they would be re-investing it all in the business. However, the goal behind most businesses is for the owners to eventually profit.
At what point do they stop investing it back into the business and start cutting themselves checks? If a member is gone for her wedding for two weeks in June is her check the same as the others? It is important to make these decisions before the money is coming in. For once it is coming, it is often the case that each individual believes they deserve more than another and an agreement may be hard to reach.
To protect the business owners
A buy-sell agreement protects the founders. You choose your business partners for a reason. Getting in to business with someone is like a marriage, except it’s often far more difficult to get out of. A well-done buy-sell will protect the founders by giving them the first right to purchase another founder’s share should they decide to sell. It will give parameters for a sale to someone who is not currently part of the business. It can also protect from situations such as divorce or death, which could thrust an unwanted member upon the existing members.
Buy-Sell agreements can help avoid conflict
Often times conflict and disputes will arise in businesses, this is especially true for new businesses. One owner may pay a bill late resulting in a significant late fee and discord among the group, for example. One member doesn’t feel she can invest personal funds anymore and needs to focus on her “day job” for a bit, and one member found out she is pregnant. She is hoping to take a paid maternity leave for nine weeks, after which she may want to sell her share and stay home.
The above outline very real and frequent situations, having a Buy-Sell agreement in place helps your business put a plan of action in place to know how to deal with these items before it is too late.
These issues can all be resolved, but would have been better (and more rationally) planned ahead. You can’t plan for everything, but you can try. If you are willing to invest money into starting a business you should be wise enough to protect your investment with some forethought and planning. If you are an investor, ask the business to provide you with their corporate documents.
If you are considering investing in a start-up business you should ask to take a look at their corporate documents. Your investment is valuable and you should feel confident that it is going to a business prepared to handle rough waters.