Insights
Legal Affairs
Agreements among owners
How agreements among business owners can prevent future problems
W
hen starting a business, owners
usually think, not surprisingly, that
relationships with their partners
will be eternally copacetic. Unfortunately,
issues among owners arise and resolution
of these issues can be both time-consuming
and expensive. A bit of planning at the outset, however, can prevent heartache later.
“Because of unforeseen circumstances
which may arise and circumstances which
business owners may foresee but choose
not to address, I advise clients, at the outset
of the formation of their business, that it is
crucial for them to enter into a comprehensive agreement with the other owners,” says
Craig M. Chernoff, a member at Semanoff
Ormsby Greenberg & Torchia, LLC.
“There are many areas to be considered
in these agreements and each business is
unique,” he says. “It is crucial that business
owners consult with their attorneys to sort
through these issues and determine the
best way to handle them.”
Smart Business spoke with Chernoff
about the importance of agreements
among business owners.
What is the role of agreements among business owners?
These agreements — primarily shareholder, operating, partnership and similar
agreements — address and govern a multitude of situations by setting forth the rights
and obligations of business owners across
a broad spectrum of areas.
What issues might owners address with these
agreements?
These issues can be broken down into four
categories as discussed below. How each issue is handled may vary from business to
business, and there is no one ‘right’ way or
answer. So, consulting with your attorney is
vital to ensure that each issue is handled in
the best way to suit your business.
n Dispositions of interests upon certain triggering events: What happens with
an owner’s interest when that owner dies,
becomes disabled, is terminated, becomes
bankrupt or divorces? Typically, owners
enter into relationships based on various
personal and business factors. When a ‘triggering event’ occurs, owners generally do
not want to be forced into a new relationship (for example, they do not want to be in
business with their partner’s spouse). Typically, agreements provide the business and
Craig M. Chernoff
Member
Semanoff Ormsby Greenberg & Torchia, LLC
the remaining owners an option to purchase
the interest of the owner affected by the
triggering event. The more difficult question
is valuation, and how it is to be paid so as
not to cripple the business. Other considerations include obtaining insurance to fund
the buyout and purchase price discounts depending on the type of triggering event.
n Transfers of interests in the business: What happens when a business owner
wants to transfer his or her interests in the
business? For example, Trey (75 percent)
and Mike (25 percent) own Piper Pipe, Inc.
Jon offers to buy Trey’s 75 percent interest
in Piper for $10,000,000. If there is no agreement, Trey may sell his interest to Jon, and
Jon and Mike would be co-owners of Piper.
Because business owners want to control
who they are in business with, agreements
may provide that an owner may not transfer an interest without first offering to the
business or to the other owners on the same
terms and conditions as offered by the potential purchaser. If Trey and Mike had an agreement, Trey would offer Piper and/or Mike his
interest for $10,000,000. Piper and/or Mike
may accept or reject the offer. If they reject,
Trey would be free to sell his interest to Jon.
Agreements may provide for ‘tag along’ and
‘drag along’ rights. ‘Tag along’ rights allow
an owner with the right to ‘tag along’ in a
sale by the other owner (favoring minority
owners), and ‘drag along’ rights allow an
owner to ‘drag along’ the other owners in a
sale (favoring majority owners). If there are
‘tag along’ rights, Mike may choose to include his interest in the sale to Jon. If there
are ‘drag along’ rights, Trey may be able to
force Mike to sell his interests to Jon.
n Management and voting rights in the
business: Agreements may provide owners
with certain management and voting rights.
Depending on the business, one person (or
a group) may run the day-to-day operations
or have the right to do whatever they want
with the business. Owners may vary voting
requirements for certain business actions.
For example, appointing officers may require
a majority, but approving a merger may require unanimity. Owners may also provide
a mechanism to break deadlocks, including
mediation, arbitration, ‘shoot out’ provisions
or even the business’s dissolution.
n Miscellaneous: Anything may be provided for in agreements among owners, if
such provisions are not contrary to applicable law. Examples are anti-dilution provisions; restrictive covenants; requirements
when additional capital is needed; escrow
and voting right provisions upon the sale
of an interest; contribution and indemnity
obligations; and truncated arbitration or
other dispute resolution mechanisms.
What steps should be taken when owners are
considering agreements?
When an owner wants to start a business
or prepare an agreement for an existing business, the owner should meet with their attorney to discuss which issues are applicable
and how to address those that are. It is often
prudent to include financial and insurance
advisers who may have greater insight into
the inner-workings of the business, particularly with regard to valuation of the business.
What is the most common error an owner can
make?
The biggest error is not having an agreement or using an ‘off-the-shelf’ agreement.
Too often, people tell their attorney, ‘We
never got around to signing an agreement,
but now my partner and I are not getting
along and we cannot amicably resolve our
differences. What can we do?’ There are solutions, but resolution of these issues is less
time consuming and expensive if there is an
agreement in place beforehand. <<
CRAIG M. CHERNOFF is a member at Semanoff Ormsby Greenberg & Torchia, LLC. Reach him at (215) 887-4835 or [email protected].
Insights Legal Affairs is brought to you by Semanoff Ormsby Greenberg & Torchia, LLC
© 2012 Smart Business Network Inc. Reprinted from the October 2012 issue of Smart Business Philadelphia.