The Planner's Perspective: Building a Business
By Paul Morrone CFP®, CPA/PFS, MSA
Running a small business is demanding work and requires the business owner(s) to wear every possible hat, especially during the infancy stages. Responsibilities are often broad and involve making decisions that can impact everything from the strategic direction of the business to the color and design of the letterhead it uses. While every business operates differently, building a strong foundation is necessary to ensure that future operations are scalable, efficient and accurately tracked. Unfortunately, many businesses are formed in haste, or without proper guidance, which can lead to ambiguity, complexity and missed opportunities down the road. These issues are further compounded if there is a partner (or partners) involved in the venture who each have something to lose if the business is not successful.
A well drafted operating agreement is one of the first building blocks that should be addressed at the onset of any business venture. Making a collective and good faith effort to establish expectations in writing can be a saving grace if circumstances change without warning. This allows all partners to be on the same page regarding matters such as voting rights and management responsibilities. The agreement should also document a process for the admittance of a new partner and the necessary votes (unanimous or simple majority) need to pass a motion. Furthermore, documenting specific items such as buy-in amounts, capital call provisions, profit/loss sharing percentages, loans to or from members, etc. are critical to each partner understanding the cash flow and tax impact of their role as an owner. It may even be wise to include a formal process that requires all managing members to approve member compensation and the timing of profit distributions from the entity. Providing all responsible parties with clarity regarding their liability and risk exposure before they sign on the dotted line can significantly reduce the chance that someone is blindsided if life throws a curveball at you down the road.
Additionally, there is a need to address the unspoken concern of ‘what happens if partner X becomes disabled or dies.’ This is something that I’m willing to bet everyone is thinking about but doesn’t necessarily say out loud, however, it is in the best interest of the entity to have a process to ensure a smooth transition after the incapacity or passing of a member. Addressing these matters up-front can prevent a partner’s spouse or other heirs from inheriting membership interests if an owner passes prematurely. This is especially a concern for a 50% or majority member who has a spouse (child, or other heir) that is not qualified to run or be an owner of the business. The buy/sell provisions can be drafted in a myriad of ways and can be either funded (i.e. by using life insurance) or unfunded depending upon the structure that best suits your business and strategic goals.
Equally as important as executing an operating agreement is enforcing it and placing a strong emphasis on corporate governance. This includes periodic review of the operating or buy/sell agreements and ratifying them if necessary. Businesses should also hold annual shareholder meetings and document meeting minutes as part of prudent corporate governance practices.
This information is not intended to be a substitute for individualized legal advice. Please consult your attorney regarding your specific situation. LPL Financial and (insert dba name) do not offer legal advice and services.