Small Business Partnerships -Protecting your Minority Stake

You do not have to rely on the goodness of human kind alone, when going into business with other people.  There are legal (agreements) and practical measures (business common sense)  that you can take to make sure that your business investment in a limited liability company, corporation or other entity does not fall prey to the shenanigans of your fellow – majority – business owners. 

Legal Protection

Enter into a written agreement (an operating agreement for an LLC or a shareholder agreement for a corporation), which gives you, the minority business owner, certain rights and protections against oppression by the other business owners.  If you do not have such an operating agreement or shareholder agreement, you will be subject to the default rules set forth in the various New York laws dealing with limited liability companies, corporations and partnerships (depending on your type of entity).  For example, if you are a minority member of a limited liability company, the majority can overrule you on almost all matters relating to the limited liability company business.  Before you know it, you will be voted off the island….

Here are some possible protections to be written into an operating agreement or shareholder agreement with your fellow business owners:

-  Very important decisions regarding the business should require your vote (aka supermajority or veto rights).  You want to have a veto right, before the other owners take out that multimillion dollar loan or welcome new owners into the company;

- Ok, sometimes it is just not practical to have a veto right on every issue you would like to have a say in.  Maybe your bargaining position is just not that strong and the other owners won't agree to your limitless power to influence all decisions for the business.  But wait – even if you do not have voting rights for a particular matter, you should be allowed to voice your opinion before a decision can be made;

-  Your 15% ownership in the limited liability company or corporation should remain 15% in voting power and value, no matter what the other owners do (aka preemptive rights).  If you do not have preemptive rights,  there are many ways in which the majority owners could dilute your voting power or make it economically worthless.

- You should have a right to a distribution of profits of the business, especially if you do not work for the company.  There should be recurring dates for distributions of profit.

- If the other owners work for the company, there should be a limit on what they can pay themselves for their work, so that profits don't get eaten up by their salaries and you end up with nothing;

- if you work for the company, your compensation and terms of employment should be clearly stated. Compensation can be a regular salary or increasing stakes in the business (aka sweat equity);

- if the company is a partnership, limited liability company or s-corporation, there should be distributions to allow you to pay taxes.  Any of these entities makes you liable for taxes on profit, whether you actually received the profit or not.

Practical Considerations

- Stay on top of the money at all times

The people in charge of handling the money and financial affairs of the business should never get the idea that nobody is watching.   If there are no checks and balances in place, anybody can get off track and start neglecting the books and records of the business.  If a shoebox is your company's accounting system, good luck showing later that you did not get your fair share.  Insist on receiving regular reports about the company's financial condition and, if possible, get at least online access to the company's accounts.  

- Foster a Good Working Relationship

Be interested in the business and keep a good relationship with the majority business owners.  Attend meetings and be open for different points of view.  A good business relationship is not that much different from a good marriage/partnership.  It takes work and the willingness to listen and understand the opposing party's interests.   

- Work Around the Lack of Written Agreements

As stated in the beginning, it is crucial to have a written agreement with your fellow majority business owners.  However, I understand that it is easier said than done.   Very often, the following scenario unfolds:  Everybody tries to get an agreement drafted, but then it just gets too time consuming, too complicated or you can't agree on one or two minor points, with the result that the agreement never gets signed.  An unsigned agreement is absolutely useless.  Meanwhile, the business is operating and generating revenues.  Three years later, a fight ensues and there is no agreement stating your rights and responsibilities and you have to go back to the default rules of New York law.  
So I suggest that you try to get something in writing…anything…..as long as it is clear that all parties involved agree to that writing.  For example, it could be an email stating that Max, Joe and Sam each own one third of the "Bestest Ice Cream Company, LLC" and that everybody has to agree before new members are admitted or payments go out to any of you (add anything else that is very important for you).  If you get an email response that says "yes, I am ok with that", it is better than nothing, when you have to proof your rights in court.   In other words, make sure that your absolute basic rights are documented somewhere and agreed upon by everybody.  Then start pushing on writing up a proper agreement.  

 

About Imke Ratschko


Imke Ratschko is a New York Attorney helping small businesses, business owners and entrepreneurs with all things "Small Business Law," such as litigation, contracts, business owner disputes, shareholder and operating agreements, sale or purchase of a business, investors, and starting a business. You can reach her at 212.253.1027.

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