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updated: 4/16/2020 8:43 AM

Why your multi-owner business needs an agreement among its owners

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  • Steven Migala

    Steven Migala

 

At Lavelle Law, if a business that we are helping to organize will have multiple owners, we will discuss the need for an agreement among the owners and the company to govern their relationship. The type of agreement varies depending on the choice of entity -- a shareholder agreement for a corporation, an operating agreement for a limited liability company (LLC), or a partnership agreement for a general or limited partnership. Below are some of the purposes such an agreement serves and why it is needed.

1. Ownership vs. Control. Management continuity and its separation from ownership is usually important for a multi-owner company, and the agreement provides for it by appointing those with day-to-day control over the company, such as officers, directors and managers. In many cases, the officers of the company and owners do not want family members who happen to inherit an equity interest to be involved in the management of the company. This separation of control from the equity ownership of the business should be agreed in writing by the company's owners. Further, an agreement should specify how potential deadlocks or disputes over management decisions are to be resolved.

2. Income and Distributions. The agreement should specify how the company's owners extract value from it. Who will decide when there are profits available for distribution? How are profits and losses allocated, pro rata by ownership percentage or otherwise?

3. Succession Planning. A properly drafted agreement should have buy-sell provisions in it specifying what happens upon an owner's death, disability or even divorce. These events may trigger a mandatory or optional sale of the affected owner's equity interest, and the agreement should specify the purchase price and other terms of the sale. Doing so creates much-needed liquidity for the equity interest, which surviving family members of a deceased owner will appreciate.

4. Transferability. Because an owner generally wants to deal only with other owners and not others who may become owners, an agreement usually restricts the transferability of an owner's equity interest by providing that if an owner attempts to sell or give his or her equity interest to a third party, the company or other owners have a right of first refusal to purchase the equity interest on specified terms. However, sometimes owners want to allow for transfers of equity interests for estate planning purposes to trusts for the benefit of family members. Should such a donative transfer trigger the right of first refusal? If the transfer is allowed, will the equity interests be subject to the agreement on the death of the transferor? The agreement should resolve these issues.

5. Restrictive Covenants. An agreement may contain restrictive covenants prohibiting the owners from competing with the company and prohibiting the solicitation of its employees and customers to move to a competitor. Such covenants generally are easier to enforce in these types of agreements among owners because the consideration for them is clearer and they are not specifically tied to employment.

6. Ensure Ability to Sell the Business. An agreement may specify the voting requirement needed to approve a sale or merger. In addition, it can provide certain rights enabling the majority of owners to force the sale of all equity interests by minority owners (drag-along rights) and, conversely, rights enabling minority owners to participate in a sale of equity interests by a majority of owners (tag-along rights).

These agreements can resolve in advance many issues that owners of a business may face down the road, and they can assist in avoiding costly litigation. Feel free to email me at smigala@lavellelaw.com or call me at (847) 705-7555 for a free initial consultation to discuss an agreement for your multi-owner business.

•Steven Migala is a shareholder at Lavelle Law ain Schaumburg and is active in the firm's banking, business, securities and M&A practice groups.