David salmon & associates
STOP, THINK, AND PLAN before going into business with others!
Joining forces with other people and businesses can bring a number of benefits including new talent, more capital, and greater borrowing capacity. But if it is not done correctly, it can bring about disastrous results that can lead to the destruction of your business.
As a business attorney, I have been called upon many times to help clean up the mess that resulted when multiple business owners failed to adequately set the foundation of their business relationship.
The following are the 15 most common mistakes I see made by businesses with multiple owners:
1. Forming the wrong type of entity.
There are many types of legal entities available to those who wish to go into business with another person: General Partnership, Limited Partnership, Limited-Liability Company (LLC); S-Corp.; C-Corp, Joint Venture, Employer–Employee, etc. The choice you make will have tax and other legal consequences. You need to choose wisely based on what your company goals are. You need both legal and tax advice to make sure your choice is a good one. Also, if you do not clearly indicate what type of entity you are forming, and what the rights of each of the parties are, you may force a judge to make the determination after a lengthy and costly litigation process.
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2. Giving birth to an entity and then failing to nurture it.
The creation of a legal entity is like giving birth. A corporation is “an artificial person or legal entity created under the laws of a state.” Black’s Law Dictionary (Sixth ed. 1990), page 340. To set up a legal entity and then to not comply with the formalities and laws associated with the maintenance of that entity is like giving birth and neglecting the child. I too often see individuals, with little or no professional help, set up their own legal entity and then fail to continue to operate the new entity in the manner the law requires. This is particularly true for those who purchase incorporation kits at seminars or online. A benefit of having an attorney help incorporate you is that you have the continued assistance of the attorney to help make sure your company continues to work in accordance with applicable laws and proven best practices. Common errors I see include failing to comply with the law related to registered agents, failing to renew state registration annually, failing to maintain a strong corporate veil by co-mingling corporate and personal funds, taking out personal loans from your business, and failing to adequately identify property as either corporate or personal. Failures like these can result in your corporate formation being disregarded by a court and your personal assets being at risk. This is referred to as "Piercing The Corporate Veil".
3. Rushing into business before having everything put in writing.
No one ever goes into business thinking it will fail. This is a common mistake and it can have devastating consequences. You need a written exit strategy in place before going into a business with someone. Dissolution of businesses not only happen in unsuccessful businesses, they also happen in successful ones. Having a well-planned written agreement will establish what the rights and expectations of each participant are at an early stage. The process of putting the agreement together will evidence the intents of the parties early in the relationship and will force the business owners to discuss issues they may not have thought of. I see too many entities set up without proper bylaws, operating agreements, shareholder agreements, or partnership agreements.
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4. Not adequately accounting for contributions to the business.
I have often seen problems arise when partners do not make identical contributions when setting up a business. Some partners will contribute cash, some equipment, some clients, some contracts, some services, and some a combination of these. Anything of value contributed to a business should be properly valued and accounted for. You must agree as partners on how to adequately value each partner’s contribution, and sometimes professional help doing it might be wise. Additionally, problems can arise when you do not adequately identify the nature of money contributed to the business. Was the money a capital contribution to be kept by the business until dissolution, was it a loan to be repaid, was it a purchase of an interest in the business? Not properly identifying money coming into the business has been the cause of serious problems later on.
5. Even numbers of voting partners without method to break deadlocks.
A partnership agreement should include some provision to address the problem of 50%-50% splits when voting on an issue. This is mostly seen when two partners both hold 50% voting rights and are deadlocked on a certain decision. It can also happen when there are more than two partners (e.g. two for, and two against, a proposal when each of the four partners have 25% voting rights). This problem can be avoided if the partnership agreement holds a provision for the vote of a predetermined non-partner individual to break the deadlock.
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6. Not adequately planning for success.
Success as well as failure can harm a business if not properly prepared for. Arguments can arise when the money starts coming in and there is no plan for where it should go. Those who feel they are bringing in more business, or working more hours, often want to change a preexisting compensation structure. Also, disagreements regarding the future direction of the business can arise.
7. Not determining early how effort and expertise is to be valued, accounted for, and compensated (managing expectations).
Those with specific skills can be essential to the success of a business. Their expertise should be valued and adequately compensated. Expectations regarding amount of work each partner is expected to contribute may help avoid conflicts over these matters later.
8. Majority interest partner not understanding the minority partner’s rights under the law and/or applicable contracts.
Just because someone has majority voting rights does not mean that individual can do whatever he or she wants to the detriment of the other business owners. Partners owe a fiduciary duty to each other and one partner cannot ride roughshod over the others. Moreover, minority interest partners have certain rights under the law such as the right to see the books and to have all information related to the business. The partnership agreement can also contain additional rights not outlined in under the law.
9. The false economy of failing to hire professionals.
All too often new businesses, in an effort to reduce costs at a time when money is scarce, will try to do work outside of their expertise without the help of competent professionals. Every new business needs an attorney, accountant, insurance broker, and sometimes a realtor. It will save you much in the long run if you hire competent professionals to help set up your business and help make important decisions outside of your skill set. As an attorney, I make the most money by cleaning up messes created by do-it-yourself business owners. This great expense could have been avoided if an attorney, or some other professional, had been hired before any major actions had been taken.
10. Trusting another to do something you don’t know how to do as it applies to the operation of your business.
If you own a small business, it is beneficial that you understand all the jobs being performed by others in your business. Do not let your employees do a job you do not know how to do. If such a job must be done, outsource it to some other company with expertise in the area that has insurance and can be held financially accountable if the job is done incorrectly. Hiring an incompetent or unethical in-house bookkeeper has ruined more than one business. A business owner may be good at producing a product or providing a service, but if he or she cannot do their own bookkeeping, they are in very real financial danger. It is also important to understand that Nevada law requires an owner to know what each of his or her partners in an organization are doing. You may be held liable for the actions of your partner(s) under Nevada law, as well as your employees. Therefore, having partners with a specialty you do not understand holds risks for you if you cannot make sure each partner is competently doing their jobs.
11. Failure to properly plan for the death or incapacity of an essential person in your business.
The death or incapacity of an essential person can bring your business to a screeching halt. If your partner becomes incapacitated, he or she is still part owner of the business and still has rights under nevada law and all applicable contracts. If your partner dies, you may find yourself suddenly in business with your partner’s heirs. These potentialities should be addressed before they become a problem. Partnership agreements, bylaws, operating agreements, buy-sale agreements, limitations on transfer of business interests, estate planning, key person insurance, etc., all can be used to attempt to keep a business healthy if some unfortunate thing happens to an essential person.
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12. Underestimating the impact a non-disclosure, non-compete, non-disparagement or other restrictive covenant in a contract can have on you and those you hire.
Contractual agreements that restrict such things as disclosure of certain information, competition, disparagement of the business, etc., can have a tremendous impact on an individual and a business. Many have signed agreements with these restrictions without given sufficient consideration to how they can eventually effect the individual or businesses future. It is possible for such an agreement to kill a young business and to keep an individual from getting a new job in the location they currently live in. In Nevada, a restrictive covenant such as those outlined here must be limited in both scope and duration. If you wish to have these types of restrictions in your contracts, make sure you get a lawyer to draft it. Also, consulting an attorney would be wise if you wish to know the significance of these types of agreements before signing them.
13. Not properly understanding the statutes and regulations associated with your business.
You must understand the laws associated with your business. Every industry today is regulated in one way or another. You must know the laws associated with your business or you may find yourself fined or facing some type of administrative action against any license you hold. A common mistake is to take a successful business from another state and transfer all of its policies and procedures to Nevada without adapting to Nevada law. It must be remembered that each state has its own unique regulatory laws which must be complied with.
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14. Failing to properly protect intellectual property.
Ownership of procedures, processes, materials, software, etc. that is created while working for a business must properly be identified and protected for the benefit of the true owner of the intellectual property. If such things are developed while working for a business, the business usually owns it. But it is possible to contract otherwise. The problem often arises when the developer of the intellectual property claims ownership independent of the business it was created in. Additionally, if you believe information owned by your business is a “trade secret”, you must protect it by contractually obligating those who have access to it.
15. Deciding that litigation is better than listening to your attorney about the above issues.
In 17 years of practice, I have never had a client tell me that litigation was faster, easier, or cheaper than he or she had anticipated. Litigation is expensive, time consuming, and emotionally draining. Although litigation cannot always be avoided, properly formed and executed contracts, policies, and business relationships, can greatly reduce the potential for long and expensive litigation.
In summary, going into business with another can either help or hurt your business. Speaking with an experienced business attorney can help you avoid making stressful and costly mistakes.
For more information contact our office by calling us (702) 382-9696 or simply fill out the form below.
The above article came from a Seminar given in 2015 by Attorney David N. Salmon. The list of mistakes are not in any particular order. The information given in this article is intended for those who go into business with others; this can be shareholders in a corporation, members of a limited-liability company, joint ventures, partners in a general or limited partnership, and other such relationships. For the ease of reading (and writing), I have often cumulatively referred to these business relationships as “partners” or “partnerships”. Also, you will note that some of the mistakes outlined herein apply equally to single and multi-owner entities.