BUSINESS FORMATION; ADDRESSING THE “WHAT IFS?”
TO AVOID DEALING WITH THE “WHAT NOW?”
The last thing I wanted to do after graduating from law school was practice law as a civil litigation attorney. The contentious nature of the litigants and their attorneys, combined with the gamesmanship of it all, makes most rational beings avoid the courtroom like the plague. But, what do I do? I’m a civil litigation attorney, and I cannot think of anything else I’d rather do for a living. I’ve learned to play the game and play at a level where, for the most part, my colleagues, although opposing me with great legal prowess, are deserving of my utmost respect and admiration. The camaraderie and unending challenge of it all gives me immense career satisfaction. That said, however, my clients, understandably, do not share my enthusiasm for the litigation process. For them it equates to torment and reversal of fortune. For many, a victory does not necessarily mean a “win” and even the prevailing party may feel like the loser after considering the litigation costs and emotional strain.
Litigation is society’s way of righting a wrong but, truth-be-told, so many of the issues litigated today need never have been the subject of a lawsuit. When it comes to business litigation, had people just dealt with the “What ifs?” prior to formalizing their business relationships, they would not later have to deal with the “What now?” It’s the “What now?” that ultimately serves as the foundation for bitter litigation. Friendships and families are forever divided over matters that could have easily been avoided if, during the excitement of the proposed business venture, simple “What if” questions were asked and honestly answered by all parties. Some of these “What if” questions are illustrated in the following story :
Jeff, a long time client, owned a manufacturing company. Jeff came to me to incorporate his business and relied on my legal expertise for his company, vendor, employee, and customer contracts. Accordingly, it was no surprise when he asked me to create the documents under which Hank, a long time trusted friend and employee, was to become a shareholder.
Hank and Jeff had been working together for over three years and Jeff was very appreciative of Hank’s efforts in helping him grow his business. Both were excited about the prospect of Hank becoming an owner and wanted the legal “paperwork” completed as quickly as possible. As instructed, Jeff made it clear to Hank it was important for him to have separate legal representation because I was solely acting as Jeff’s attorney and was obligated to act in his best interest. Hank agreed and retained an attorney to assist him.
As happens in most cases, the parties are so excited about the future they consciously avoid discussions which might dampen their enthusiasm or jinx the entire venture. Jeff and Hank were no exception. Jeff, however, being a little more sophisticated than many, resisted the temptation to proceed without addressing some fundamental “What if” questions and asked Hank the following:
1. What if sometime in the future Hank, you or I decide we want to devote less than our “full-time” efforts to this company; how are we to address our respective ownership interest?
2. What if the company, at some time in the future needs an infusion of money; are you Hank willing to obligate yourself on a loan or will you be willing to contribute some of your own cash?
3. What if either you or I become sick or incapacitated and are unable to work for an extended period of time; how are we to equitably compensate the burdened shareholder.
4. Hank, knowing it is my desire to retain the controlling interest; how will we address future growth where we might deem it in our best interest to extend an offer of ownership to others? How might we handle the dilution of interest?
5. What if one of us should die; how are our families to be treated?
6. What if we reach an impasse with respect to a business decision; how shall our impasse be ultimately resolved?
7. What if one of us succumbs to temptation and embezzles; is forfeiture of stock an adequate remedy?
While there are a numerous other “What if” questions, just posing these few can sometimes lead to unexpected revelations. In Jeff and Hank’s case, Jeff found out Hank was not interested in the responsibilities that come with ownership. Hank decided, after considering the “What ifs”, he would rather be an employee working in another industry. Hank left Jeff’s company and they parted as friends. Had Hank become an owner, his lack of commitment would have soon become an issue. Just a few months after Hank left, sales of a product developed by Jeff skyrocketed and Jeff was forced to infuse the company with over $200,000 of his own money. Jeff launched his company to the next level and remains the sole shareholder.
Jeff has thanked me no less than 10 times for encouraging him to address these “What ifs?” before he gave away a portion of his business. Jeff claims he dodged a bullet. He did.
Business formations, with even just one other person, must be treated with the care and consideration one would give to the most important decisions of their life. When you consider all of the time and money you will spend building your business, in contrast to losing it all because of inadequate agreements and documentation, stellar legal representation at the formation stage is a must. Operation agreements, shareholder agreements, management agreements, buy-sell agreements, and the like are expensive but still only a fraction of the cost of litigation.
Incorporation and LLC formation documents can be purchased online for a few hundred dollars. A competent business transactional attorney will cost a few thousand dollars and up. A good business litigation attorney, in just the average lawsuit, will cost tens of thousands of dollars. With respect to litigation, a solid six figure legal bill is not uncommon; and there are those who break the seven figure mark. Prevention, along with excellent legal advice, buys more than just piece of mind; it could prevent ultimate financial ruin.