Whenever beginning a new business relationship, first sit down and think about how you want the relationship to function. Setting clear rules and expectations in advance can save you time, money, and headaches later.
No matter the circumstances, this pre-planning is essential. You’re already in business and want to joint venture with another firm to do a special project, or bring in a new co-owner? You’re starting a business with a good friend or trusted colleague? It's still the same: setting clear rules and expectations in advance can save you time, money, and headaches later.
Ultimately, the desired outcome of this reflection is the preparation and finalization of a detailed written agreement that sets out each party’s rights and responsibilities and governs their business relationship. A carefully crafted agreement will memorialize your intentions and set the foundation for a fruitful business relationship for years to come.
But where to begin? How to boil down a complex relationship into a standalone written agreement? Fortunately, there are key legal issues that come up time and again when starting new business relationships.
Where to Begin: Structuring Your New Business Relationship
Below is a list of many key points that come up time and again for new business relationships. You should begin by reviewing and noting your reactions and desired outcomes for each issue. If there are items with which you are unfamiliar, flag them for discussion with a lawyer.
Once you have come up with a wishlist for these key points, it is time to discuss the issues with your prospective partner. In these conversations, it can be useful to prepare a non-binding term sheet to aid the parties in covering all items fully and without confusion. The term sheet will serve as a roadmap to a full and binding agreement down the road.
Again, to prepare and negotiate a term sheet, consultation with a lawyer will be helpful. An experienced business lawyer can provide guidance on common solutions to the different legal issues and can draft acceptable language on key points. Moreover, by having the lawyer work on the term sheet from the very beginning, it will be less costly for preparation of the final, binding written agreement (which, most certainly, will require a lawyer’s touch to prepare properly).
First, though, consider your responses to the questions below.
Key Issues to Consider for New Business Ventures
Who is Participating?
Are you each acting as individuals? Are you existing business entities joining forces? Will you be entering into an agreement directly with the other business, or will there be new entities formed specifically to enter into this transaction as intermediaries? Where are the entities formed and entitled to operate?
Type of Relationship
Are you forming a partnership? A new limited liability company? Which form of legal entity will your new business take? Is a new entity even required or can this be done by a straightforward transactional contract?
Nature of the Business
What will the business actually do? Is it limited to specific opportunities? How long will it operate? Is it limited to particular geographical region or free to do business anywhere? Will it compete with other business of the parties?
Contributions to the Business
What is each party contributing to the business? Money? Property? Time and skill? Something else? A combination thereof? When will such contributions be made? Will there be additional monetary contributions in the future? What happens if a party does not make its required contributions?
Control of the Business
How does each party participate in the management and control of the business? Who will handle the day-to-day operation? Will there be a third-party manager? Will one party act as manager, or will the partners act in unison or as a committee? Will the manager have specific duties or general powers? Will the manager be required to adhere tightly to a business plan or budget or be given free rein? Are there certain major decisions that require special approval of the parties? When can a manager be removed from control of the business for bad behavior or poor performance? Will a managing party receive compensation or reimbursement?
What happens when parties cannot agree on a course of action for the business? Is there a plan for resolution of deadlocks? Can a party buy out the other party? Or force a sale of the business or certain assets?
How will the parties share in the profits of the business? Will one party receive a preferred return, promote, or some other preferential treatment with respect to their interest? When will profits be distributed: at a specific time, upon occurrence of a specific event, or some other scheme? Will distributions be completely discretionary, or will there be minimum required distributions (e.g., for tax liabilities)? And what exactly constitutes profits of the business? What obligations of the business must be satisfied before profits are distributed?
How will the parties share in the losses and liabilities of the business? How will liability be limited? Will the parties indemnify each other? Will the business indemnify the parties? Will the parties indemnify the business? Will the parties ever be required to personally guarantee any debts of the business?
Transferring Interests in the Business
Can partners freely transfer their interests in the business to third parties or are there limitations on who can buy an interest in the business and become a co-owner? Is there an approval process for allowing new co-owners to join the business? Will parties have a right of first refusal or offer with respect to prospective transfers? And what actually constitutes a transfer (e.g., an indirect transfer, a transfer of beneficial interest, etc.)? Are certain parties (like family members and affiliated companies) exempt from restrictions on transfer?
Insuring the Business
What types of insurance, if any, should the parties and the business carry to protect all interests involved? Potential policies to consider include public liability, Internet, personal injury, property damage, fire, theft, workers’ compensation, D&O, etc. How will compliance with insurance requirements be enforced?
Resolving Conflicts and Enforcing Rights
How will disputes be resolved? Will there be limitations on the ability of the parties to resolve certain conflicts? For example, will arbitration be required in lieu of litigation? Will remedies be limited? Will litigation, if allowed, be limited to certain venues? Will the parties be able to resolve conflicts by forcing a buy-out of their interests or a sale of the business or key assets?
Effect of Death/Insolvency/Bankruptcy
What happens if a party dies, is found insolvent, or declared bankrupt? Does the venture dissolve, wind up, carry on in some limited capacity or otherwise continue without the affected party?
Representations and Warranties
Have the parties made any representations and warranties that should be memorialized in a formal agreement?
Records, Accounting, and Taxes
Who is responsible for keeping company records and handling accounting? How often and by what means will other parties have access to review records? Will a particular party serve as the responsible party for tax communications?
Once you have reflected on the above, it may make sense to negotiate a non-binding term sheet with your prospective partner to come to an initial agreement on these key points. The term sheet can be used to inform and structure a final, binding document to govern your business. An experienced corporate lawyer can assist you in preparing a thorough, thoughtful, and well-crafted term sheet.
About the Author
Alexander Liroff is the sole attorney at Liroff Law, where he works passionately to help businesses of all shapes and sizes accomplish their goals. Mr. Liroff is admitted to The Florida Bar (2009). For 7 years, Mr. Liroff has practiced corporate law, working for 1,000+ lawyer firms and small businesses alike. He has practiced law in-house and as outside counsel to small and medium-sized businesses. He has represented multinational corporations and mom-and-pop start-ups.
Mr. Liroff holds an undergraduate degree from Dartmouth College, a master’s of science form he London School of Economics, and a juris doctorate from the Columbia University School of Law. His areas of study have ranged from the esoteric (philosophy and political science) to the scientific (genetics and cell biology) to the practical (law).
You can email Mr. Liroff at email@example.com.