In both business and romance, the early stages are filled with starry eyes and optimism. Nothing can possibly go wrong – but if it does, the partners will face it together. In real life, however, things are rarely that neat.
One fundamental error made by many start-ups is failing to have essential business documents and agreements in place from the beginning. Partners often hold off on putting key terms in writing because in the early stages, when everyone is enthusiastic and in sync, they can be loath to interfere with the thrill of getting a new business off the ground.
But having basic partnership or incorporation papers that outline each party’s roles and obligations, as well as other agreements more specific to the type of business, is key to preventing problems down the road.
In fact, companies that use lawyers and have documentation in place are more likely to succeed than those that don’t. Wherever there’s ambiguity, there’s conflict.
In addition to specifying founders’ roles, partnership and incorporation documents lay out a plan for what will happen if there are changes among company principals, or if the business shuts down altogether. People can quit, relocate or die, so a buyout clause is a necessity.
Companies that fail can leave behind assets that will need to be sold or distributed among the owners. Talking about these transitions beforehand will save time, money and hurt feelings later.
Agreements should be negotiated as early as possible – ideally before opening the doors, but certainly before the business accumulates value or takes on debt. Once the business starts gaining value, things start getting touchier – it’s better to do it in the beginning when people are on equal footing.
Clear incorporation documents prevent unpleasant surprises, such as a smaller-than-expected share of sale proceeds, which can lead to legal disputes that cost money, ruin reputations and destroy friendships.
The partnership or incorporation agreements are also closely related to the financing of the business, so they should be drawn up before seeking outside capital. If one founder is providing a significant amount of the capital, it’s particularly important to have a lawyer review the paperwork.
Company founders who go into a financing negotiation without having their own agreements in place beforehand will be particularly vulnerable to a financing arrangement that strips them of control or limits their upside if the firm is sold.
A legal matter
Start-ups often stall on legal agreements because the founders prefer to put their limited resources into sales, marketing and product development.
Many lawyers who work with entrepreneurs are willing to negotiate payment agreements, such as deferring some billing until financing arrives. Standard business organisation, nondisclosure and other agreements can be used to get a conversation started and to prepare for a meeting with an attorney, reducing billable hours.
Entrepreneurs often want to do it all themselves, but that can be a recipe for disaster. Legal work is one task that’s easy to outsource and important enough to the success of the business and its relationships to justify the time and expense. It’s also a good first exercise in delegation. Don’t be the CEO, COO, CTO and lawyer at the same time.
Here’s the deal
Legally, when two or more people start a business, they are considered to have a general partnership and share equally in the assets, liabilities and profits – unless they sign an agreement that states otherwise.
In addition, you may consider drafting other agreements, such as: a non-compete agreement, which restricts the ability of a founder or key employee to leave the company to work for a competitor; a non-disclosure agreement, which may help protect intellectual property; power of attorney, which can give the other partners the ability to handle business decisions in case one partner is incapacitated; and an arbitration agreement, in which the parties agree to send any disputes to an arbitration panel instead of resorting to litigation.