When you launch a business, you are full of optimism. You believe that nothing will possibly go wrong and if it does, you and your partner will handle the situation together. However, in real life, the situation is different.
Many startups don’t have important agreements and documents in place when they start out. During the initial stages, they simply don’t feel the need to put important terms in writing. Their enthusiasm deludes them into thinking that such formalities aren’t necessary. At this stage, they don’t want to spoil the thrill and excitement of getting the new venture off the ground. However, none of these are valid excuses for not having proper documentation in place. If you are serious about your business, you should have important incorporation and basic partnership papers outlining each partner’s roles and obligations. You should also have other agreements specific to the kind of business. This will prevent problems down the lane.
Companies that have employed lawyers and have proper agreements in place are far more likely to succeed that those that don’t have any documentation in place. If you leave room for ambiguity, there will be conflict.
Besides specifying the role of founders, partnership and incorporation papers explain what will possibly happen if there is a change in the core principles or if the company shuts down altogether. Then there are cases when people relocate, or even die. That is why having a buyout clause is a necessity. When an organization fails, it may leave behind valuable assets that need to be distributed or sold among the owners. If you discuss these things beforehand, you will be able to save time, resources, and bitter feelings later.
You have to negotiate agreements at the beginning itself. Ideally, this should be done before opening the business. In case you didn’t do that, you have to ensure that all agreements are in place before the business takes on debt or accumulates value. When the business gains value, things will begin to get touchier. It is important that you prioritize these agreements early on.
HOW IT WORKS
Since businesses and business partnerships are governed at the state level, rules can vary depending upon the area where you operate.
HERE’S THE DEAL
When two people launch a company, they are said to enter a general partnership that requires them to share the assets, profits, and liabilities equally, unless they put their signature to another agreement which states otherwise. The simplest business model is sole proprietorship. A general partnership, on the other hand, shares ownership among two or more persons. It doesn’t provide any protection against personal liability. So, if someone wins a lawsuit against the business, the personal assets of the partners may be forfeited.
The obligations and tax liabilities usually depend upon the kind of business you have incorporated.
In the case of a Limited Partnership, the investors have limited liabilities. A Limited Partnership business has two kinds of partners: General partners and Limited partners. General partners retain liability and make the decisions. Limited partners contribute most of the money, but their liability is limited. The partners will have to pay tax on their individual share of profits. Most investment companies have this structure.
LIMITED LIABILITY COMPANY (LLC)
In the case of a Limited Liability Company, the founders are allowed to form an independent entity that has limited liability. This will protect their personal assets from forfeiture in the unfortunate event of bankruptcy or a lawsuit. Each owner has to pay taxes on their share of profits.
C Corporation: The most common kind of corporate structure, the C Corp allows owners to set up a distinct legal entity which has its own tax obligations and risks. A C Corp can be set up inexpensively. It is particularly helpful for large organizations that seek flexibility in ownership.
S Corporation: Much like a C Corp, an S Corp allows the owners to establish a separate company that has its own liability. However, this structure passes the tax liabilities to each investor. If the business is interested in taking on outside financing, this structure can make it difficult.
Depending upon the structure of your company, you’ll have to pay taxes and handle the finances.
It is possible to customize the agreements for establishing these structures to account for management changes that might arise in the future. Besides these agreements, you may consider preparing other agreements. For example, a noncompete agreement may prevent a key employee or a founder from leaving the company and working for a competitor. The nondisclosure agreement may help protect individual property. The power of attorney will give the other partner(s) the ability to make business decisions if one of the partners is incapacitated. In the case of an arbitration agreement, the partners agree to send disputes to an independent arbitration panel.