There is a cliché that you should never go into business with your friends because they will soon become former friends. This is particularly true with business entity formations.
Starting a business is a positive move. One tends to think of the success you will have and how great things are going to be. While this is natural, smart business planning also requires you to consider the potential for things to go poor. If you form a corporation or limited liability company for your business, this can be particularly true.
Assume you and a couple of friends come up with a great business idea. You jointly agree you should form a corporation or LLC to make sure you are all protected if things go poorly. This is a smart move for a wide variety of reasons, but you need to take extra steps.
When forming a business entity, most people are worried about getting sued for something. This is known as an external risk concern, to wit, a customer or vendor sues your business for doing something wrong. There is, however, also an internal business risk that most people don’t think about.
An internal risk is essentially problems between the shareholders of the business. At the outset of the venture, everyone is enthusiastic and going to work hard to reach the desired goals. After a year or even a few months, the situation can change. One or more of friends involved suddenly stops showing up for work. Perhaps they show up, but just don’t do much. Maybe one person ends up fronting all the working capital and grows bitter over the process. In short, the friendship/business is degrading.
Eventually, things will come to head. Certain shareholders will want to boot others out of the business. At this point, they think about firing the person. While any employee of the corporation or LLC can be fired, there is a problem. The fired party is still a shareholder in the entity. Once fired, the person is no longer required to work, but still has a right to a percentage of profits that equals their shares in the entity or membership interest in an LLC. The remaining “working” owners are going to be very unhappy.
If you decide to go into business with your friends, or anyone else, you need to deal with ownership issues up front before you start earning revenues. The key question is to determine how ownership disputes will be handled and put it in writing.
Richard A. Chapo is with SanDiegoBusinessLawFirm.com -
incorporate in California.
