So you are thinking of starting a business or changing the participants, what issues should you be concerned about? Many businesses are started on oral agreements and optimism, after all, it takes a certain amount of optimism to strike out and start a new enterprise. However, leaving things to oral agreements, no matter how good of friends or honest the prospective partners may be, is dangerous and is a major reason for litigation between former business partners. The problem with oral agreements is not that they have no legal effect, but rather that it is very difficult to prove the terms of the agreement. Perhaps more importantly oral agreements are subject to misunderstanding. It is far better to reduce the agreement to writing so that all parties are working from the same guidelines; the very act of putting it in writing can often shed light on potential misunderstanding before they arise. This is not to say that written agreements cannot be misunderstood or misinterpreted, but it is much easier to prove the terms of the agreement if it is in writing. This article does not attempt to address in great detail each and every issue which may arise, as those are innumerable.
It is very important to get appropriate professional advice prior to taking any action in regard to creating a business entity, adding or removing members or partners or winding one down. This includes not only legal, but tax and even insurance advisors. While there is a cost involved, the costs involved pale compared to those incurred in litigating a matter which has caused ruin and misery for many a business. Remember, nobody goes into a business deal thinking that they will be litigating with their partners and yet it frequently happens.
When creating a business there are a number of issues which should be evaluated, including which form would be best for the purposes of the partners and this will often require a tax and legal analysis on both the business and personal level. In addition, since it is possible for personal obligations of the partners to infect the partnership, it is a good idea to have a frank discussion of any current or potential liabilities which the partners are aware of. This may actually inform the parties to utilize a different form of business altogether. If it is a partnership, there should be a written partnership agreement governing the various responsibilities of the partners and various possibilities which may arise including, but not limited to; what happens if someone wants to leave, or someone dies, is divorced or someone wants to be added. This holds true for limited liability companies (LLC) as well, although in that case it should be handled in the operating agreement. Every LLC should have a written operating agreement which should address the same types of issues, but also what responsibilities and authority the various members or managers have. The goal should be to address the issues which might arise in the future should circumstances change and by putting it into writing to help forestall issues in the future. This is also an excellent time to undertake some asset protection analysis with your attorney and tax professional. Starting a business is risky and if it fails, it would be wise to have assets protected where possible.
If you are considering adding or removing a member (in an LLC) or partner (in a partnership), there are different issues to address. What are they required to do to become a partner/member, does there need to be a corporate action taken (vote of members), what liabilities are they assuming, if any, will there be tax liability to anyone from the action being proposed? If the member or partner is leaving, similar concerns should be addressed. In both situations, it would be wise to consider discussing the possibility of indemnity for liabilities with the partnership or LLCs insurer, if applicable. This is also an issue which should be considered and put into the partnership agreement or operating agreement from the inception of the business. If a particular agreement does not deal with these issues, now is a good time to consider them and amend the agreements before the issues arise.
Lastly, if the enterprise fails or the members/partners otherwise wish to stop operating, this should not be left to chance. Again, the agreement should set out who is responsible for filing the final tax returns, liquidating assets, paying off debts, etc. However, in the case of an LLC, a formal winding down should be undertaken to minimize the potential for claims to arise down the road. A formal winding down includes notice provisions to possible creditors, and once that period ends, if the process is done properly there is little risk of future claims. However, many small business owners neglect this and merely “stop”. That doesn’t suffice from a legal standpoint and does nothing to cut off liability to potential creditors or those which existed at the time the business ceased operating.
Obviously, these are just some of the issues to consider when contemplating making changes to your business or to starting one. Of course there are many more and books have been written purely on the issue of choosing the form of business for tax or for liability purposes. This blog is not exhaustive and is merely intended to help its readers to be able to ask the right questions and seek the appropriate professionals and to take stock of what they are attempting to accomplish and how best to achieve that.