When forming a business, conventional wisdom requires that the business be a legal entity that provides limited liability protection, such as a limited liability company.
This is also the case when a company needs additional capital by allowing investors to participate as equity owners in exchange for an injection of cash into the company. But business owners should be forewarned. Business endeavors become infinitely more complex when the ownership pool includes other people.
The easiest way to set up and run a business is to have only one owner. In most cases, the interests of the couple are so closely aligned that I would count them as her one owner. The process of forming a one-owner LLC is simple, as are the required documents.
Those forming an LLC in this manner can usually choose a boilerplate LLC organization document that does not require much customization. why? The sole owner has the unilateral power to change the business at any time of his choice. In effect, the owners are not bound by any enforceable provisions within the company that prevent them from making any possible decisions against the company. It's easy.
Just introducing one more owner makes the calculations very different. Kudos to the TV show for popularizing the concept that full control equates to 51% ownership, but in reality this is not the case and relying solely on the default right to control ownership is a public liability. I don't know.
Consider the example of an LLC in which Fred owns 60% and Julie owns 40%. Let's assume that Fred exercises his authority and declares that the LLC needs to purchase assets (perhaps inventory or land). To obtain the necessary financing, banks may require all owners to sign the loan agreement in their personal names, similar to the practice with small business loans. By default, her 60% owner of the LLC cannot force her 40% owner to provide a personal guarantee unless a customized agreement addresses this. Therefore, the 40% owner has de facto veto power.
Similarly, a buyer may offer to purchase an entire business in an LLC ownership sale in a transaction that pays 10 times the true value of the business, provided that the buyer can purchase 100% of the company. Again, 40% owners can effectively refuse to sell.
More important than simply saying that one owner is “in control” and the other is not, it is important to carefully discuss the decision to go into business together. , there are many issues that need to be agreed in writing. These agreements are often included in the operating agreement, but they can also be included in a separate agreement between the owners.
Continuing with the Fred and Julie example. Further assume that they own a landscaping business, with Julie funding the operation as an investor and Fred, the majority owner, managing it. Although Fred is “in charge,” there are many other issues he would like to strengthen beyond those outlined above.
Business owners typically want to keep important business information and trade secrets confidential. Perhaps Fred and Julie would have to agree to keep all business information confidential. Can Julie sell her interest in her LLC to a competitor or someone else? Without having to address this with a customized contract, Julie can sell to anyone she chooses.
There are issues that Julie would like to address to feel more confident about investing. Imagine that Fred is buying fertilizer and pesticides from his girlfriend's brother. It costs a little more, but it stays in the family. Should Fred be required to disclose this, or should he be prohibited from engaging in transactions that personally benefit him? Can Fred start a competing landscaping company? Can Julie? ? Can Fred independently choose when and how much profit is returned to the owners, or can he unilaterally choose to use the funds to foster growth or increase his own salary? What if Julie pays taxes on the business's profits but doesn't receive enough dividends to cover the taxes?
In some cases, owners may want to involve family members in the business. Do Fred or Julie have the right to demand that their child be employed by a landscaping company? What about Julie? Should she be able to work for the company?
Remember the distinction between ownership and permissions. The two do not need to work together. An individual can own her Microsoft stock, but has no right or obligation to work for the company.
Other forms of doing business as a business entity include limited liability partnerships, corporations, sole proprietorships, and partnerships. Still, businesses with multiple owners face similar challenges.
This article just scratches the surface of the planning opportunities when forming an LLC with another person. There are many other issues to discuss, and many ways to address each. Work with an experienced attorney to plan for matters like these and many more.
Beau Ruff is an attorney and planning director at Cornerstone Wealth Strategies Inc. in Kennewick, Washington.
