As business attorneys, we are routinely surprised how often successful business partners do not have agreements governing their business relationship. Before people get married, they usually give a good deal of thought to whether their partner is right for them. They may take months or even years, to see if what they have with the other person can survive through good and bad times. Even then, before entering into a marriage, many people make sure that they have a written agreement (a prenuptial) spelling out what will happen if they decide to end their marriage. Have you done the same for your business?
Paperwork and Documents to Start a Business
You may be surprised to know that when people get together to start a business, then often take none of those precautions. Even though they may be investing huge sums of money and countless hours sacrificing time away from their families, and even though many people who enter into business relationships with others may be experienced business people, they often do not take the time to think about—much less put into writing—what will happen should things between the business partners go sour.
The amount of paperwork that must be drafted and filed will depend on the kind of business entity the business partners are forming. Even when some paperwork is drafted at the start of the business venture—for example, articles of incorporation, operating agreements, partnership agreements, or bylaws—those documents are often written without detailing how a partner, shareholder, owner, or manager can leave or be extracted (kicked out) from the business by the other partners if need be.
Why Partners or Shareholders Leave a Business
There are many reasons why business partners or shareholders leave voluntarily, or get extracted from the businesses that they own and helped found.
Partners may feel another partner is not pulling his or her weight. Partners may get jealous over other partners’ earnings. Personal squabbles unrelated to the business at all may lead to a partner leaving or being forced out. Sometimes, a partner just does not want to be a part of the business anymore for personal reasons.
Issues When a Partner Leaves or is Kicked Out (The Divorce)
There are a lot of legal problems that can come up when a partner, manager or shareholder seeks to leave a business, or when he or she is pushed out of one. Any one of these issues can lead to extensive litigation, but put together in a “business divorce,” they can lead to years of court struggles, and often, emotionally charged issues.
In many cases, a member of a business may receive both a share of business profits, as well as a regular salary. A business looking to “fire” a partner can end up with a big problem. Let’s assume Partner A is “fired,” and thus, whatever salary was being paid by the business to the partner or manager, ceases.
The first legal issue is whether the firing is legal, which will depend on state employment laws. Colorado is an ”at will” employment state, meaning that someone can be fired for any reason at any time. However that may not apply when there is a contract promising continued employment. The fired employee may argue that partnership or management agreements or other contracts contain language sufficient to constitute such an employment contract.
Then, even if the partner is legally “fired,” this may end his or her ability to work for the company and draw a salary, but may not cut off rights to share in the profits of the business as a partner, manager, or shareholder.
That means a business that fires a partner from continued employment but does not alter that person’s status as a partner can find itself having to pay dividends or profits or partnership moneys to someone who has been fired, and is effectively doing nothing for the business anymore.
Business Property and Competition by a Former Member
Over time, the business has likely amassed tangible and intangible assets. For most businesses, personal property like desks, computers and certain inventory can be replaced, but intangible assets, like customer lists, special methods of doing business, past records, intellectual property rights, or forms and documents are irreplaceable and have a much higher value.
Unless a partner signed a non-solicitation agreement, it can be difficult to keep a former partner from obtaining and using current or potential customer lists when and if the partner sets up a competing business.
That partner may have brought thousands of customers or clients into the business when it formed, and may have a reasonable claim that those customers are his or hers.
Even without customer lists, a former partner can take his or her know-how, expertise, and personal relationships with customers and the community to a new business venture. This is especially true if there are no provisions for a non-compete agreement in the event a partner or manager leaves.
Angry partners can even resort to illegal activities, such as raiding bank accounts while they are still authorized account signers, or removing physical property.
Many courts will protect businesses by prohibiting partners from using proprietary information or training received while a partner, to compete with the partnership. Some courts have held that this kind of information belongs to the company, and thus, any ex-partner taking or using this private information is theft. Without anything in writing, this is still something that must be determined by a court.
Handle These Possible Problems From the Start
There is almost no limit to what you can put into writing; anything that all the partners agree to can be put in an agreement or provision.
Just like in a personal relationship, it can seem distasteful in the beginning to discuss how property will be divided should someone leave or be kicked out. Given the flexibility and general amicable nature of the relationship when the business is first formed, this may be the best time to spell out everyone’s duties and obligations on paper, in the event a breakup occurs.
The end result of thinking about these things from the beginning can be a clearer picture of everyone’s rights from day one, as well as minimizing the time, cost, expense and risk to the business that extended litigation can cause.
Reviewing your business documents, contracts, and agreements now can save you lots of time and money later on. Contact BBU to review your documents or help you get started with a new business venture the right way.