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When Two or More Tango: The Need for an Owners Agreement

Posted Monday, August 12, 2013 by Michael A. Larson

alt textRunning a business or investing in real estate can be a thrilling endeavor. Partners are a good way to share the risk and bring in additional capital or skills. If you want your entrepreneurial thrills to be positive when working with a partner, your chances are better if an owner’s agreement is in place. In corporations, owner’s agreements are typically called a Shareholder’s Agreement. In limited liability companies and partnerships, owner’s agreements are usually called Operating Agreements. No matter what form of business you elect, these owner’s agreements cover much of the same territory, including governance, accounting, raising capital, and other technicalities of operating a business together.

Typically, an owner’s agreement provides for restrictions on competition. When things get tough, you do not want a co-owner to open a competing business. A departing owner’s knowledge of business practices and customers can be a death knell for the jointly-owned company. Noncompetition provisions have restrictions based on time, geography, and scope. For example, the restriction may be no competition or solicitation of business and employees within 100 miles of the business in the same business segment while being a co-owner and for two years after leaving the business. Noncompetition clauses circumvent a co-owner’s ability to simply leave and compete if matters are not going their way.

 A central theme to owner’s agreements is a blueprint for the owners of a jointly-owned business to leave in an orderly fashion. The buyout options are usually implemented as a result of an event, such as the co-owner’s death, disability, failure to participate in the business, loss of the business interest through seizure of assets by creditors, or even divorce where the co-owner’s spouse might be awarded a share of the business. The list of potential reasons to implement a buyout of a partner is extensive. These reasons are commonly called triggers.

Once a triggering event occurs, the owner’s agreement specifies the terms of buying out other partners. Often, all other owners and the business entity will have the right to engage in the buyout. The owner’s agreement may specify a purchase of the departing owner’s interest in the company in equal shares by the remaining owners. Some agreements provide that majority owners or other specific owners will have the sole right to purchase the share of the departing owner.

 Owner’s agreements typically provide a mechanism to determine the price of the buyout. Many agreements specify an agreed price that is updated by the owners. Others provide computation of the purchase price based on industry standards to value businesses, book value, or market value after an appraisal process. Similar to triggers, there is a long list of approaches to valuing a buyout. There can even be different purchase prices for the departing owner’s interest based on which trigger implements the buyout. For example, if an owner stops working within the first year, a buyout may be triggered at 10% of the value of the interest. When the owner stops working after 10 years, they may receive 100% of the value of their interest. This trigger would encourage long and dedicated service. An owner’s agreement can also provide whether the buyout will be in cash or in installments over time.

Bottom line: If you’re doing business with partners, an owner’s agreement is essential. Without an owner’s agreement, dealing with the departing owner results in a morass of issues to resolve with very little guidance. With an owner’s agreement, an orderly transition while retaining good relations with your former partners is far more likely to occur.

For more information, contact Michael Larson , PLLC at (206) 340-2008.

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