Ownership Changes Part 2: Adding an Owner

Small Business Attorney Ownership Changes Adding an Owner

This post is the second in a series addressing the legal and technical ways that a new owner is added to a business.  In the first post, I stressed the importance of getting an agreement in writing.  Although I discussed this in relation to a new investor, the importance of getting an agreement in writing applies to any kind of a new owner.  Get it in writing!

 

In this second post, I’ll talk about adding a “partner” to your business – someone who will be involved in the management of the business with you.  Maybe you’re considering a partner who has resources that will help you grow your business. Or maybe you’re thinking about bringing someone on board who can help you manage the business so that you’ll have more time to focus on the big picture.  Or maybe you’d like to have someone associated with your business because he or she has beneficial contacts and a reputation for making things happen.

 

In any event, you’re going to be sharing your business with a new owner.  You’ve made the decision, you’ve talked it through with the new owner and you are comfortable moving forward.  You and the new owner have agreed on how things are going to work – generally.  After doing this for over a decade, I’ve realized that most people don’t know all the things they need to talk about with the new owner.  That’s understandable – you talk about the things you can think of.  Unless you’ve taken on a partner a couple of times in the past and have had some troubles, you wouldn’t know all of the things you need to iron out first.

 

So here’s some key points for you to discuss with the new owner:

 

  1. If you have an existing operating agreement (LLC) or shareholder agreement/bylaws (corporation), both of you should read it to see if it will still work. Chances are, it won’t.  That’s because it was probably written before you contemplated taking on a new owner.  If it won’t work, you can either amend it or write a new one.  If you don’t have an existing agreement (maybe because you’ve been the only owner), you absolutely now have to have one.  The posts in this series discuss why it’s so important to get an agreement in writing.

 

  1. How is the new ownership going to be transferred? Will it come from the business or will a current owner be selling some his or her own interest?  If it will come from the business, the business will “issue” the interest directly to the new owner and the new owner will pay the purchase price to the business, to be deposited into the business’ account.  If a current owner is selling some of his or her own interest, the new owner will pay the current owner and the purchase price will be deposited into the current owner’s personal account.  Before you decide, consider whether the business needs the influx of cash.  Also consider the tax implications of each way and discuss this with your accountant.

 

  1. How will the purchase price be paid? If the new owner can pay the purchase price all at one time, then great.  If he or she can’t, then you’ll need a promissory note showing the amount owed and the payments to be made over time.  Additionally, there should be some security for the note, so you’ll need a security agreement stating what happens if the note does not get paid.

 

  1. How much management authority will the new owner have? What is the procedure for making decisions?  Are you splitting it up so that each of you will have decision-making authority over certain aspects of the business?  For “major decisions,” will both of you have to agree?  Keep in mind that it is very difficult for people to agree all of the time.   You don’t want your business to stagnate while you’re trying to hash it out with your partner.  Think of ways to keep things flowing.  Work through which of those decisions are so important that all owners to have to approve – but keep these to a minimum.

 

  1. What will the new owner’s title be? These days, titles aren’t that important to us. But in the law, titles come with authority.  If you have a corporation, will the new owner be on the board of directors?  Will they have an officer title?  If you have a manager-managed LLC, will the new owner be a “manager”?  This decision fits in with the topic in #4 – management decisions – because each of these positions has certain decision making authority.  That authority should be well defined in your operating agreement (LLC) or in your shareholder agreement and bylaws (corporation).  And don’t forget to update the information with the Florida Division of Corporations.

 

  1. Will the new owner be an employee of the business? This one is tricky.  If the new owner will be paid a salary (in addition to a share of the profit), you need to have provisions in your agreement that covers his or her duties as an employee.  The reason it is tricky is that an owner does not have to be an employee.  Let’s say that a new owner doesn’t perform well as an employee – or that the new owner doesn’t put in the necessary time – and you no longer want to pay his or her salary because it’s a drain on the business.  What can you do?  Can the new owner be fired?  If you fire the new owner (because it says you can in your written agreement), can he or she still be an owner of the business or does he or she have to sell the ownership interest back (and at what price)?  These are all things that should be set out in your written agreement.  It’s much easier to address at the beginning than it is to deal with the uncertainty and arguing that can happen later.

 

  1. If (notice I say “if” and not “when” because I’m an eternal optimist who plans just in case things go wrong) – if things don’t turn out well with the new owner, can the new owner take the information they’ve learned from you and set up a competing business? Your answer should depend on whether the new owner already had the ability to compete before joining your business.  If you feel it’s appropriate, consider putting a non-compete clause in your written agreement – but remember, Florida has restrictions on the length of time and geographic area for non-compete provisions.  Non-compete restrictions are not appropriate in every situation.  However, you can always have a confidentiality provision, so that if the new owner does go his or her own way, he or she cannot use or disclose your customer lists, business processes, trade secrets, and other information you define as “confidential”.  You can also have a non-solicitation provision so that the new owner cannot solicit your customers, vendors or employees.

 

As I stated in the first post in this series, there are securities laws that must be considered when adding a new owner to your business.  These do not only apply to investors – they apply to all types of new owners.  You may need to take certain actions to comply with these rules.

 

The next post in this series will address issues you need to consider when you promote a valued employee to an owner of your business as well as more suggested terms you should have in your written agreements.