In the past two weeks I’ve met with two different potential clients who are considering bankruptcy because of failed business ventures. That of itself isn’t unusual because the large majority of start-up businesses fail within the first five years. Both of these potential clients have something else in common, and that is that in both cases they had partners who suddenly left them to run the businesses alone and with all the debt. Sadly, that isn’t all that unusual either.
When friends decide to go into business together, no one expects the business to fail. Each party figures the other will work as hard as they will to make a success and that hard work plus the killer product or service that they’re developing will be enough. Little, if any, thought is given to the form of the business. Will it be a corporation, a limited liability company, a partnership? How will ownership be determined? Who will contribute what to the business? How will the parties be compensated? Are both going to devote their full time to the operation of the business?
If the new venture needs money, the owners often go to a bank for a loan. Maybe one of the parties doesn’t have much to offer as collateral so the other puts up her house. Maybe she’s the only one obligated on the loan. If that’s the case, she should have an agreement with the other owner that they will be responsible to her for any payments she has to make if the business can’t pay the loan.
In both of my cases, the founders had contributed equipment and one had contributed money. With that money the business bought more assets, remodeled space, paid for advertising and hired employees. When the business failed, the one who had contributed property thought she could just take back her equipment and that she was entitled to be paid for one-third (there were three partners) of the business. It’s turned into a mess for everyone.
A lot, if not most, of this could have been avoided by a carefully drafted agreement or agreements that address all of the questions I raised above. Would it have prevented a possible bankruptcy? Maybe not, but it would have made the problems each of my potential clients are facing much more manageable.
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