As a partner at Bernkopf Goodman Law Firm, Martin Pomeroy advises clients on a variety of business issues and offers his insight on the most common problems new businesses face.
(Photo courtesy of Martin Pomeroy)
Not surprising, the most significant hurdle small businesses confront is capital. The founder/owner must decide where to allocate limited funds. Legal fees are expensive, and often these small businesses forego necessary documentation of important agreements.
This is where a trusted legal advisor can be invaluable. The attorney who takes the time to learn and understand a client’s business and most pressing needs earns that client’s trust and can guide the new company through the process making sure only those very necessary documents are crafted and implemented early on. As the business grows, other important but ancillary documents and agreements can then be crafted to protect the growing enterprise.
This becomes even more pertinent when two or more individuals are involved with the business. The most important document to craft is the one setting forth their business arrangements. Many small businesses forego this resulting in significant conflicts that divert time and resources away from business growth at a time when the focus should be targeted to prospects, not conflicts. A trusted legal advisor who understands the difficulties small businesses face will help insure against such diversion.
Typically, these ‘missing’ agreements often involve money. Since capital is tight, small businesses with multiple partners often avoid addressing the ‘what ifs’ when things do not go as planned. For example, if in year two the business suffers a downturn and needs capital to fund operating deficits, where does this cash come from?
The most equitable arrangement would be to have the owners fund the deficit pro rata in accordance with their stock ownership. If this requirement is not established in a written agreement at the outset, the potential for conflict is clear, particularly where there are only two owners. This can often result in one owner funding the entire deficit.
This failure to address the issue gets compounded. Now that one owner has funded more than his pro rata share, what premium should he receive for that advance? Absent a written agreement, the owner who did not fund his share can simply say none and not much can be done about it. A proper agreement would set forth not only the obligation to fund but also the entitlements/punitive results that will occur for failure to fund. These can include a variety of remedies, including a high-interest loan to the defaulting owner, loss of voting rights and even dilution.
The other very significant item that should be addressed is an exit strategy. The owners should have a clear understanding of how they want to get out. The worse time to address this issue is when an offer to purchase is presented. Not only does this create a conflict at that time, but assuming an agreement to sell is not reached, ongoing resentment by the owner who wanted to accept the offer and exit could threaten the ongoing viability of the venture. Likewise, having a clear understanding of what happens in the event of the death of an owner should be established.
Failure to do so can often result in an ‘unwelcome’ partner. This also presents a planning opportunity for succession. That is a topic often neglected. If addressed properly, not only is the succession path established, but also how repurchase rights will be funded can be agreed upon and set forth, ensuring ongoing stability. These are just a few of the many issues small businesses face that should be addressed before significant capital is infused into a new venture.
This article was written by Robin D. Everson of Examiner.com for CBS Small Business Pulse.