Often a few friends want to start a business together. Before signing on the dotted line, before renting office space and buying furniture, before ordering business cards, ask yourself how your relationship with this new company might end.
Often businesses begin like marriages—with romantic hopes and rose-colored glasses. Entrepreneurs often fail to plan for contingencies or “what ifs” in the event the business fails or the relationships sour. Even in highly successful businesses, founders ultimately retire or pass on.
Failing to plan an exit strategy can result in an expensive business divorce. If owners are deadlocked, one party must sue the other and let the courts dissolve the company. That outcome will cost all of the founders money in legal and accounting fees. They also will be forced to pay a court-appointed receiver to sell the assets of the company. Money, however, is not the worst part. More expensive are wrecked friendships and shattered business relationships.
Before you start a business with anyone—brother, cousin, acquaintance, childhood chum, or friend—draft an exit plan. The following are options that founders should consider building into their organizational documents:
- Triggering Events—What happens if a founder dies? Do the remaining partners want the heirs of the deceased founder to become involved in the company’s decision-making process? What if a founder wants to retire? The owners can decide that if such events happen, the other partners have the right to purchase the problem owner’s equity.
- Deadlock Resolution—What if the owners deadlock over how to run the company? A deadlock resolution mechanism will solve the problem. A popular solution is often called a “push-shove” agreement: One partner offers to buy the others out. The other stockholder can either sell at that price or buy the other partner out for the same price.
- Bring-along rights—What if a third party offers to buy out the company, but only one of the founders agrees to sell? “Bring-along” rights force the other partners to sell, assuming the price meets a certain threshold and the sale is to an unrelated party who will “bring along” the other equity holders.
- Pricing Mechanism—In order to avoid deadlock over how much the company is worth, founders should agree on a valuation method at the outset, such as an adjusted book value or fair-market value as determined by independent appraisers. In addition to a valuation method, the founders should also choose a financing method for buyouts.
- Noncompetition and nonsolicitation—After an equity partner has left, the last thing the remaining partners want is for the departing person to take his contacts elsewhere and start competing against the company. Noncompete agreements prohibit departing members from disclosing confidential information and luring employees and customers away.
No matter what the venture or the pre-existing relationship of the founders, everyone will be best served by thoughtful, contingency planning at the outset.
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