A good way for many people to get a business started is with a partner. The partner may bring many things to the business: expertise, funds, moral support, another body to get things done, and so on. Partners are usually excited about going into business with each other and for good reason! The potential to create something really great for yourselves seems more palpable and real when you are united with a like-minded person in your endeavour.
But like a marriage, friendship or any other close relationship with another person, there is always the potential for the relationship to change. That is why a person should never go into business with one or more partners without making sure all the parties' intentions are clearly set out in writing in a legally binding document. Usually, this means having a partnership agreement or a shareholders' agreement drawn up and signed.
Getting one of these valuable documents made up achieves many things, but some of the most important are these:
Clarifies what everyone really means Although everyone seems to be in agreement, there are so many things that may crop up in the future that each party may not have turned her mind to, that it is virtually impossible that everyone will have intended to handle things the same way. The process of creating the shareholders'/partnership agreement will help get to the bottom of what everyone really means.
Gives you a guide for handling "situations" Who will decide what the rules are for changing the way you do things, making decisions (large and small) in the future, and dealing with disagreements and differences of opinion later on? Especially when it appears that one or more parties is putting in more effort than the others or the business needs funding and not everyone agrees or has the same amount of spare cash to put in? These differences can have significant dollar value attached to them! A proper partnership agreement or shareholders' agreement will tell you how to handle these situations. When putting one together with an experienced lawyer, you will be asked to consider very important scenarios that you may not have thought of, and to provide rules for the possibilites that could occur. This aspect of a partnership agreement or shareholders' agreement can save you substantial grief and money down the road, and actually help keep you out of court.
Ultimately, the agreement gives you legally enforceable rights If things break down and your partner(s) aren't abiding by what you agreed to, you may end up in court. That is when your written contract can allow you to prove what the parties agreed to. Had you not made an agreement in writing, it will be your word against your partner's, and the outcome will be a big unknown.
Q: Our business is incorporated. Aren't my incorporation documents good enough? Incorporation documents do not create a binding contract between the parties; they essentially create the corporation as a separate legal "person" from its owners. They just aren't designed to address the actual carrying on of business between the parties. In addition, although the corporate by-laws may contain some rules, many companies are created with minimal terms and documentation at all, and many others have standardized terms that have not been fully thought through as a contract for conducting future business. Basic business law rules provide for certain types of decisions to be made by different percentages of the shareholders of a company and these may not protect you adequately in your situation. Very frequently they are completely inappropriate.
Q: What's the difference between a partnership agreement and a shareholders' agreement? A partnership agreement sets out the rules where business partners have decided to run their business directly, themselves, without incorporating a company to own the business, and to hold the assets themselves. There is more potential personal liability associated with doing business this way, but for a fledgling business people often feel the costs of incorporating and doing the accounting for a corporation are too great. A shareholders' agreement is made among the owners (shareholders) of an incorporated business. Sometimes the shareholders are holding companies and they must be party to the shareholder agreement. Under corporate law, the directors of a corporation may be personally liable for certain decisions or actions of a corporation, but by signing a shareholders' agreement with certain terms and conditions in it, they may be able to relieve themselves of this liability and pass it to incorporated shareholders.
Q: Our company is still very small. There's nothing to worry about. Perhaps, but if your company grows, will any of you feel differently about your rights and obligations? Will it be okay if the party with all the client contacts or expertise suddenly thinks he could do better on his own and leaves with the contact list? It is easier to agree about everyone's rights in the future before self-interest crops up in a situation like this, and before the company grows much. (And yes, the right to leave and/or compete with the business in the future is a usual matter dealt with in these types of agreements!)
Q: Won't the existing law protect me? Business law has evolved very differently from, say, family law or landlord and tenant law. That is because in some areas of law parties are considered hugely inequal in their wealth, power and access to legal rights. Residential tenants often have little in the way of personal power in the face of a landlord, and similarly, children and spouses who give up their careers historically had no way to protect themselves from a future of poverty if cast out of a marriage, so lawmakers have intervened heavily in these areas. However, courts treat business people as though they are more or less equal (generally) and try to balance protection against the freedom to agree and contract as they see fit. Therefore, the laws largely rely upon the parties to set out their own terms of agreement in order to be as flexible as possible with a vast variety of business arrangements.
This discussion was meant to highlight some of the basic reasons for having shareholders' agreements or partnership agreements. Look for a future post touching on some of the important issues your shareholders' agreement should deal with.
Information in this article is intended for general guidance and interest, and is not to be treated as legal advice. Readers should always consult a qualified lawyer with their own particular fact situations in respect of legal advice they may require.