Four friends went into business together operating a night market, holding big events in a local
city every two weeks. Each of the friends contributed $2,000 in cash for start-up capital, expecting a 25% interest in the company.
- Adam had the business idea and asked Betty, Camala, and Duane to be part of the business. Adam was unemployed at the time and was available to work on the events 100% of the time.
- Betty had a part-time job, but quickly decided to quit and work for the company full time.
- Camala was 6 months pregnant and was available to help when the company started but soon had the baby and plans eventually to go back to her job as an independent contractor.
- Duane had a full-time job and would only be able to provide limited support, mostly in marketing the events.
The friends used a generic online legal form to create an LLC as equal members but did not create an operating agreement because the state didn’t require one.
By the third event the markets had already become popular and were bringing in a lot of money.
Adam and Betty started to push “buyouts” on Camala and Duane, suggesting that Camala and
Duane were somehow bad friends to expect 25% of a company they were not going to work at.
Adam and Betty have now basically hijacked control of the company, blocked access to bank
accounts, business documents, accounting, and funds to anyone but themselves. Camala and
Duane have not seen a dime of the profits. Adam and Betty seem to only want to talk about their
original buyout offers of $5,000 for Camala, and $8,000 for Duane, with no ongoing ownership.
While the facts may vary, such casual business startups among friends or family are common.
This scenario demonstrates all the things that can go wrong without proper planning.
Question:
If these friends had come to you before starting the business, how would you have advised them?
Include in your analysis:
- What steps should have been taken before money changed hands?
- Is an LLC the best option? Some form of partnership? Other options? Explain your choice thoroughly.
- While the friends each initially contributed cash, how should they value the non-cash contributions of time and labor in determining ownership shares, distribution of profits, etc.?
- Was an operating or partnership agreement necessary? What should have been included?
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Guide On Rating System
Vote
Before starting the business, I would have advised the friends to take the following steps:
1. Clearly define roles and responsibilities: It is essential to establish each friend's role in the business and their level of commitment. This includes determining the time and labor that each friend can contribute, as well as any restrictions or limitations they may have. This will help avoid misunderstandings and conflicts in the future.
2. Consult with a lawyer or business advisor: Seeking legal advice is crucial before entering into any business venture. A lawyer can help the friends understand the legal implications of their business structure choices and guide them through the necessary steps to protect their interests. They can also help draft important agreements and contracts.
3. Create a detailed business plan: A comprehensive business plan should be developed, outlining the goals, strategies, and financial projections of the business. This plan will serve as a roadmap for the friends and will help them make informed decisions and avoid disputes.
Regarding the choice of business structure, an LLC or partnership may not be the best options in this scenario. Given the disparity in the level of involvement and commitment, it may be more appropriate to consider a different structure such as a corporation or a joint venture. These structures allow for more flexibility in terms of ownership percentages and distribution of profits based on the individual contributions and roles.
The value of non-cash contributions, such as time and labor, should be carefully evaluated and agreed upon by all the friends. A fair method for determining ownership shares, distribution of profits, and decision-making authority should be established. This can be done through a combination of factors, including the initial cash investments, the level of involvement, and the value of non-cash contributions.
An operating or partnership agreement is essential in this scenario as it would have clearly laid out the rights, responsibilities, and expectations of each friend. It should have included provisions for decision-making processes, distribution of profits, dispute resolution mechanisms, and conditions for buyout or exit. Additionally, provisions should be included to address the situation where one or more friends have a change in their level of involvement, such as Betty quitting her part-time job or Camala's temporary absence due to pregnancy. This agreement would have provided a framework for addressing these issues and avoiding the current conflicts.
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