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Why Partners And Co-Shareholders Need An Agreement
Practical insights from powerhouse attorney, author and speaker Bradley Bailyn.
There’s an old saying, “Dig your well before you’re thirsty.”
That especially applies to the need for an agreement between shareholders and partners to preserve and protect their various legal and pecuniary interests in the enterprise of which they share ownership with others.
The cost of a well drafted shareholders agreement, (and we are going to be using “shareholders agreement” for what is needed between co-owners of a corporation, a partnership, or a Limited Liability Company, even though technically, they would have different names), is far less than what it can cost in the absence of an agreement and the presence of a dispute among owners and/or their heirs.
Co-ownership of an enterprise is in many ways like a marriage. You have to be careful who you choose as fellow entrepreneurs. You have to work at the relationship, and you have to know the consequences of “trouble in paradise,” when what began as a dream team turns into a living nightmare.
The time to have an effective shareholders agreement in place is ideally at the beginning of the enterprise, but the reality is, many small business corporations, partnerships and Limited Liability Companies don’t have them at the start.
The next best time to have such an agreement is as soon as possible after learning that you need one and don’t have one; in other words, NOW.
It frequently happens that after the business “honeymoon” is over, one shareholder is looking at the other and thinking, “What do I need this guy for, I’m bringing in most of the business, I’m doing most of the work, but he/she is still getting half the profits.”
Or perhaps things are going just fine when suddenly the other owner dies or becomes disabled and can no longer perform the usual and customary functions on behalf of the corporation.
Another scenario is one day one of the owners wants to, or needs to sell his shares in the enterprise, and the terms and conditions of a sale need to be addressed--immediately.
These are everyday business occurrences, and when there is no agreement dealing with these possibilities, tempers run high, and even higher run potential legal fees.
Okay, you’re convinced; you need a shareholder’s agreement. But what goes in it?
There is the administrative portion of the agreement; provisions as to where the bank account will be, what the various tasks of the shareholders are, how many signatures are needed to write a check over a certain amount, what voting rights there are, what the salaries of the owners will be, if any.
Then there is what I like to refer to as the contingency portions of the agreement, what happens if someone wants to sell, what happens if someone dies, what happens if someone becomes disabled.
A good shareholders agreement will cover all of these matters. Equally important, a good shareholders agreement will have provisions where the issues of duties, salaries, procedures and valuations in the case of sale, death or disability will be periodically revisited to accurately assess the business evolution and then current worth.
Smart shareholders will realize that the agreement, like the business, will evolve and grow to accommodate the current realities of the enterprise.
An attorney experienced in drafting and negotiating these agreements can be of immense help and counsel to the entrepreneurs co-owning a business. He can discuss and review what is needed, and suggest ways to facilitate the execution of the provisions of the agreement should the need arise.
As an example, you can have a provision in an agreement as to what happens in the case of a shareholder death, what the price will be of the deceased owner’s shares and what the terms of payment will be. But if the fiscal reality of the corporation is such that those terms cannot be effectuated, the agreement isn’t worth very much.
So an intelligently drafted agreement may have provisions for life insurance to be in effect to fund the buyout of the deceased’s shares, so that his estate beneficiaries are compensated, and most importantly, paid and prevented from coming in and trying to run the business when they have no business in doing so. (This often takes place when there is no agreement in effect, and the litigation costs between the parties seeking to gain or maintain control of the enterprise can ruin the business).
There can also be insurance provisions for what is known as “key man” insurance, protecting the business when an owner dies who was crucial to the business operation. The money in place is paid to the corporation to compensate for the loss while the replacement personnel are being sought.
In cases where one shareholder wants out and wants to sell his shares, a properly drafted agreement can provide alternate means of share valuation, and construct the terms of the payout to dovetail with other legal agreements and business realities existing at the time.
For example if a business is renting its location for a certain number of years, you wouldn’t want the payout (from the point of view of the seller of shares) to continue beyond the lease term. (Often a lease in addition to the shares can be used as collateral to secure the payout).
You entered into business to make a profit, not to lose it when certain foreseeable contingencies arise. You entered into a specific business based upon your knowledge of the nuts and bolts of the chosen enterprise, but you didn’t go to law school, you haven’t drafted numerous shareholder agreements, and you don’t have the expertise to draft your own agreement without the assistance and input of an experienced attorney.
If you are reading this post and share ownership of a business enterprise, it’s not a matter of if you need an agreement amongst the shareholders/partners/members, the reality is you need one, and you need one now. The risks are too great not to have one in force and effect.
It is always preferable for shareholders to determine on their own, the future of their business, guided by a knowledgeable attorney, as compared to having a man in a black robe that sits at the front of the courtroom and knows nothing about you or your business tell you what you are going to do.
Business litigation can be a walk in the burning desert sun, so dig your well before you are thirsty and contact an attorney to have him draft a shareholder agreement for your enterprise.
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Bradley R. Bailyn, Esq. , Founder
Bradley R. Bailyn, Esq., is a New York City-based attorney, author and speaker with practice area expertise in commercial real estate and bankruptcy law. Prior to founding The Bailyn Law Firm, Mr. Bailyn served as in-house counsel for multiple companies, where he advised on all legal aspects of major business and financial transactions including private equity, spin-offs, real estate, and restructuring transactions, for more than thirteen years.
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