For many years, we’ve heard why it may be a good idea to have a pre-nuptial agreement (“pre-nup”) before getting married, particularly if one or both spouses has significant assets or children from a prior relationship. Owning and running a business with someone else is a relationship that can be as emotional and complicated as any marriage. Having an agreement with your business partner, a “business pre-nup”, is even more essential than a marital pre-nup, even if (maybe especially if) your business partner is your spouse or another family member.
What Is a Business Pre-Nup?
A business pre-nup is an agreement between the business owners concerning how they will set up and run the business. It typically deals with topics such as: 1) what each owner will contribute to the business at start-up, 2) each owner’s title and area of responsibility in the business, 3) how to handle funding the business, 4) what happens if an owner dies or becomes disabled, 5) what happens if additional owners are brought in, 6) what happens if an owner wants to leave the business, and 7) what happens if the business is sold or is liquidated.
The exact name of a business pre-nup will vary with the form of the business. It may be called a partnership agreement, an operating agreement, an LLC agreement, a shareholders’ or stockholders’ agreement, or a buy-sell agreement.
Advantages of a Business Pre-Nup
“But we get along so well, I’m sure we’ll figure it out.” “Why do we need to define our relationship?” “I’m sure we’re going to be successful. Why do we need to think about negative things?” “We don’t need no stinkin’ paper!” These are all things you may hear engaged couples say. But prospective business partners say the same things. The same optimism and euphoria that an engaged couple feels at the start of their marriage is also present when people start a business together. So why interrupt all of these good feelings to prepare an agreement?
1. Planning for Success
Like pre-marital counseling, preparing a business pre-nup requires the business owners to think about how to deal with the various steps of starting and running a business, including some of the day-to-day aspects that may have been glossed over during the “courtship” phase of the relationship. For example, will all of the owners be involved in all phases of the business, or will each be in charge of a certain area? Will all of the owners have to agree on every decision, or are there certain decisions that an owner can make without needing approval by the other owners? If the business needs more money, will all of the owners have to contribute? What if one or more owners don’t contribute? These issues may not be as interesting as deciding how to divide all the money that the business is sure to make, but working them out is essential to the smooth operation of the business. It is better to work them out before a crisis arises, when stress and emotions may keep the owners from thinking clearly. Remember the old quote, sometimes attributed to Benjamin Franklin: “If you fail to plan, you are planning to fail!”
2. Protecting Your Investment
The business owners will be investing significant time and money to start the business. It only makes sense to decide how to protect that investment if the unexpected happens. For example, what if one of the owners dies? Will the deceased owner’s family take over that part of the business? Will the other owner(s) be required or have the option to buy out the deceased owner’s share of the business? How will any buyout be funded? Again, it is better to think about these issues before the crisis hits. Some possible protections, such as insurance, need to be in place before the event occurs.
3. A Different Perspective on Your Business Partner
Observing how each owner acts in the course of preparing a business pre-nup may provide valuable clues about how that owner will act in running the business. This may reinforce the owners’ decision to start the business or, possibly, lead them to rethink their decision. If so, it’s better that this occur before the owners invest still more time and money.
Future articles in this series will discuss, in more detail, the following parts of a business pre-nup:
• Part 2: Money In
• Part 3: Money Out
• Part 4: Running the Business
• Part 5 The Big Picture – Growing the Business
• Part 6: Disaster Planning
• Part 7: Exit Strategies
Disclaimer: The information in this article is not, nor is it intended to be, legal advice. The law changes frequently and varies from jurisdiction to jurisdiction. You should consult an attorney for advice regarding your particular situation.