A New Year, A New Business, and A New Of Hope Of Communication
Aloha and Hau’oli Makahiki Hou!
I hope this finds you all well, and I thank you for visiting our legal blog or blawg. How has your first week of 2017? Ready to dive into new projects? For those of you thinking this is the year or the time to start a business, well then today’s post and the couple of posts that will follow are for you. Specifically for those of you interested in starting a business, especially with business partners who will own the business with you. The overall theme of these posts is about communicating. The source of this inspiration for the theme? My own partnership with Trejur launched last year my lecturing for a communications class at HPU, and I always get this question: Can my business partner do that?
Part I, Communicating With Your Business Partners
So today’s post is on communicating with your business partners, the one following this post will be on communicating with third-parties outside of the business entity you form with said partners, such as clients, customers, vendors, suppliers, contractors, etc …, and finally, the last post shall be about communicating with the government and various agencies.
Where it All Begins: Communicating, Not the Paperwork
So many of you that know me or have followed me, know that I started out as a solo practice working with small and medium-sized business clients on contracts and compliance work, such as forming limited liability companies. Over the years, as my workload increased I took on other contract attorneys to assist with the workload. Along the way, I met my commercial litigation partner, Trejur P. Bordenave. Trejur and I worked well together, and a lot of it was based on effective communication. This is the foundation that led us to the partnership we have today. In fact, he and I spent a good portion of the early part of 2016 discussing the partnership before formally launching the partnership itself.
Why am I telling you this?
One of the biggest issues I see when clients come to me to form a LLC or a corporation is they just want the documents. Yes, as a business attorney, absolutely I can draft your Operating Agreements or Corporate Resolutions, file your Articles of Incorporation, and/or obtain your Federal Employment Identification Number, and so forth, but typically, when someone like Trejur is called up to represent someone the dispute stems from a breakdown in communication and trust, amongst the business partners. There is not necessarily anything wrong with the paperwork, but the business partners did something, not necessarily maliciously or with intent to deceive, but their expectations about how the business would work, how they would get paid, reimbursed, when that would happen were all at different levels. Let me use two examples of how this can play out to illustrate.
So these following examples are fictional, but they are issues I have seen before in a wide-variety of starting businesses or in the midst of a business dispute. Again, the point here is to illustrate that good communication is the foundation of a good business relationship, which in turn drives the drafting of the legal documentation.
Example One: Majority Member and Unfair Distributions
Kai and Russell open a new restaurant business. They organize a LLC. The LLC Membership Interest (or Ownership Interest) is divided 60% for Kai and 40% for Russell that is because Kai has contributed more cash and equipment (valued at $60,000.00) into the LLC as his Initial Capital Contribution than Russell. Russell just agrees that he will bring some of his old recipes from a prior business with him and agrees to work for the LLC for the value of his Initial Capital Contribution because they are in a rush to open the restaurant they draw up a generic Operating Agreement that recognizes the 60/40 split and that everything from that, including voting, profit/loss allocation, distributions, etc . . . will be 60/40.
Five months later, after the restaurant has been up and running, Russell quits and wants to terminate the LLC. Why? Well, he feels that Kai treats him more as an employee because he feels he owns the majority of the LLC and that Russell needs to work off $40,000.00 or what Kai believes Russell’s fair share of the contribution should be. Further, due to the majority position Kai takes his cash distributions at the beginning of the month, and gives Russell his distributions at the end of the month and if there is not enough for budgeting purposes states the LLC will just owe him later.
Example Two: Discussing Officer Duties Prior to Incorporating
Lisa and Jessie want to start a solar design and installation business. They intend to incorporate a corporation, which shall issue 1000 shares, where Lisa would own 550 shares and Jessie would have 450 shares. Lisa would like to be President as she has more local connections and is the one who can bring in more clients whereas Jessie will likely do the grunt work. However, Jessie is concerned that Lisa is President and has more shares so as a minority shareholder she fees unprotected. Lisa and Jessie meet and discuss this issue.
They decide that through their Articles of Incorporation, Bylaws, and Resolutions that the corporation shall only have the offices of President, Secretary, and Treasurer and that Jessie shall be both Secretary and Treasurer. Further, that Lisa as President must submit a marketing budget for the next fiscal year to Jessie as Treasurer on the June 20th before Jessie will cut checks from the corporation’s expense account to where she will have sole authority to cut checks from. They also agree that all 1000 shares (unanimous consent) must vote in favor of declaring dividends before money is paid out as such. Finally, both agree to sign Employee Agreements stipulating to what their compensation, benefits, work hours, etc . . . on top of their rights and obligations as shareholders of the corporation. Both are satisfied with this arrangement and move forward to incorporate.
So What Happened? What Should You Consider for your Business Partnership?
In my first example, the business partners were in a rush, failed to communicate expectations, and felt that once they had the paperwork everything would resolve itself. But as trite as it may seem, they did not talk about their feelings and by signing an Operating Agreement that just split everything according the Ownership Interest percentage it did not really reflect on how they were going to do business with one another. In the my second example, discussing how Jessie felt about her worries and concerns allowed them to create a process, a mechanism of a check and accountability that they discussed and agreed to.
At this point, I’d like to put in your mind a lot of people think that once the file their Articles of Organization or they come up with the Bylaws these are set in stone. That is not necessarily the case, the owners of the business can always amend them if they are in agreement. Also consider if you and your partners are not sure what the final arrangement will look like, that is you are in an ongoing negotiations, but you have stipulated to some terms or have an inkling about where your arrangement is heading, you can always use a Memorandum of Understanding or Letter of Intent or whatever document applies to stipulate to what has already been discussed or agreed to, and agree to return to the matter at a later time to finalize. Communicate and trust each other, but keep a record of it.
Often times, people do not slow down to consider how they want to structure their decision making processes, their rights and duties to each other, to the business. Their feeling is that making money will resolve all that, but then the issues come up overtime like . . . Why do you get reimbursed for parking when I take the bus? I bring in all the clients and you do all the work, and marketing and networking is work. The recipes I brought with me are the value of the food company so I should get a majority interest. I’m the older brother so I dictate the operations just like the way our father and grandfather did it. And so on and so forth . . . if you thing your dispute is ridiculous with your business partners, I’m pretty sure there are ones even more crazy.
Sit Down and Discuss Expectations
What isn’t crazy is sitting down and discussing what you expect out of the business relationship and what you expect out of your business partners before forming the business entity and doing business. In many ways having a business partner is like getting married it is for better or worst, and business divorces are ugly affairs like regular divorces. Therefore, it is worth the time to sit-down and talk it out, and then if you are wondering can we arrange our business partnership according to what was discussed that’s when you can give me a call and we can work out . . .
What is the difference between a Member-Managed and Managed-Managed LLC? Can I contribute services in exchange for stock ownership? What are the differences in liabilities for a General Partner versus a Limited Partner? Can we have percentages of Ownership Interests that do not match Distributional Interests? What about having two-levels of Ownership Interests? Should we limit the powers and authority of the President?
Mahalo for reading this post. I hope you have a Happy and Fortuitous New Year! See you next time!