Ownership Changes Part 1: Taking On an Investor

With One Spark 2015 just around the corner, it’s a good time to think about what it means to add an owner to your business.  Whether your business is an LLC or a corporation, the issues you need to consider are the same.  Taking on an investor, partnering with someone new, or promoting an employee to an owner is a big step.

 

Thinking about all of the possibilities and opportunities that One Spark offers to new and expanding businesses, I realized that most people don’t know about the legal and technical ways that a new owner is added to a business.  This post is the first in a series that will address the issues you need to consider when you welcome a new owner to your business – whether it’s an investor, someone with skills to help your business grow or a valued employee.

 

First of all, the most important thing to remember is that you need to have an agreement IN WRITING!  I know, you’ve heard this before, over and over and over.  But it’s that important.  If you don’t have an agreement with the new owner in writing, it could be devastating to your business.  You would be surprised at how many people know this but they don’t do it – smart people, business savvy people – it’s easy to get caught up in the moment and forget (or ignore) this very basic requirement.

 

Let’s say you have an investor who wants to invest a significant amount of money in your business.  And you’re excited!  This money will allow you to expand your marketing, purchase necessary equipment and really take your business to the next level.  You like this investor and this investor likes you and thinks your business has serious potential.  You and this investor talk things over and you’ve agreed on the deal, worked out all of the money issues and you’re ready to move ahead.  Again, you’re really excited!  You are seeing all of the things you can do with this money to expand your business and fulfil your vision.

 

You accept the investment money and forge ahead to bigger and better things.  But you and the investor never put your agreement in writing, or if you do put it in writing, it never gets signed by both of you.  You’re busy.  Things start out great and you’re making strides.  You’re happy and the investor seems happy.

 

But something happens and now the investor is not happy.  The investor starts questioning your decisions and your progress, or the investor wants to do something that you don’t want to do, or the investor was supposed to give you more money (in traunches) but is now refusing to do so.  Your relationship deteriorates and now you and the investor can’t agree on anything.  You’re stuck.

 

At the beginning, it was easy when you and the investor agreed on everything.  But now that you don’t agree on much of anything, how are you supposed to move forward?  Do both of you need to agree to make a business decision or can you just go ahead and make it?  What if the investor takes some action on behalf of the business – like hires a new employee or buys some materials – and now the business has to pay for it?  You are frustrated and confused as to what you can do.

 

Without an agreement in writing, things can quickly become messy.  I’ve seen it so many times that I’ve lost count. If you don’t have an agreement in writing, it’s a guessing game, it’s a lot of arguing, and it’s probably going to be a lot of attorneys’ fees.  But most of the time, people don’t start out thinking that “this is going to go bad” – that’s because business people are generally optimists and are comfortable taking calculated risks.  So they move forward without putting their arrangement in writing.  After all, who wants to go talk to a lawyer?

 

But here’s the catch – it’s much easier to agree on terms at the beginning when everyone is positive and agreeable.  I love this phase because there’s so many possibilities for my customer’s business to grow.  I love the enthusiasm and the ideas and the possibilities.  Because I, too, am an optimist. But I am also practical, which means that I like to have things lined up.  So while things are going well, I can focus on moving forward and I know that contingencies are in place.  Then if things don’t go well (notice I said “if” and not “when”), I know what my options are.  The path has already been agreed upon and put in writing.

 

The importance of putting an agreement in writing cannot be understated.  Get it in writing! An agreement in writing sets out the standards and expectations for moving forward together.  It defines the roles each of you will have.  It specifies how major decisions will be made and it defines what those decisions are.  It states when the investor will infuse money into the business and it clearly states whether there are any strings attached.  It reduces the risk of disagreements and misunderstandings because you’ve discussed the issues and agreed upon how things will work.  It’s in writing and signed, so any questions can be answered by looking back to the contract.  Having it in writing protects you and the investor – but most of all, it protects your business.

 

From the investor’s perspective, a written agreement is beneficial and most of the time considered a requirement for the investment to take place.  Take this requirement seriously.  If you are given an agreement to review, read it carefully and make sure you understand every word.  Before you do anything, make a checklist of all of the deal terms you have talked about and agreed upon.  Then – this is important – make sure each of the terms on your checklist is in the written agreement.  Most of the time, problems occur because of what the agreement didn’t say.

 

Don’t worry about having to accept the agreement as it was presented to you.  Discuss it.  Negotiate it. While no deal is absolutely perfect – because we all have to compromise – it should be something you are absolutely comfortable with it.  It’s better to walk away from a deal that you aren’t completely comfortable with than to go forward and not get what you want (or worse).  If you’re not sure what to do, ask someone you trust for their advice.  If you don’t know what you don’t know, then talk to an experienced business attorney.

 

If your investor is another company (rather than an individual), be sure to determine the person who will represent the investor company.  Who is your contact person?  Does that person have the authority to make decisions on behalf of the investor – in other words, can you rely on what he or she tells you?  Even if you are dealing with an owner of the investor company, you’ll still need to be sure that he or she has full authority (without having to go to a board or other owners) to make decisions regarding your relationship.

 

One last note – when you take on an investor, there are securities laws that require certain actions.  Depending on the circumstances, and the sophistication of your investor, these actions could be simple or complex.  The consequences of not following the rules here are serious – you may even have to return the investor’s money.  This topic is too involved to cover in this series, but I’ll be covering it in a future blog post.  Just be aware that there are rules you need to follow.

 

The next posts in this series will address issues you need to consider when taking on a partner who will be involved in the business (more than just an investor), issues with having a valued employee become an owner, and suggested terms you should have in your written agreements.