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.
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.
- Stay on top of the money at all times
- Foster a Good Working Relationship
- Work Around the Lack of Written Agreements