Business Agreements Should Be In Writing
It's Important to Cover the "Legalities" First.
Entrepreneurs can be hasty, a bit impulsive. Often when a couple of entrepreneurs form a business, they are in such a rush to open their doors that they decide to leave the "legalities" for later. This is a big mistake. You should not consider any multi-owner business arrangement unless the “legalities” have been taken care of in advance.
Everybody is in love at the beginning. Remember the song “Will You Still Love Me Tomorrow”? You and your future partners have come up with a great idea and are excited about launching it. The future looks great—what business idea doesn’t have a great future? The market looks great, the product line looks great, your partner-to-be looks great and, to him, you look great. Ain’t life great?! Any possible disagreement will be smoothed out easily. If something unforeseen happens, you’ll handle it then. Why waste time on nit-picking details now? You guys have a business to launch. Well, pardon me for being unromantic, but let me disturb your romantic notions with a few questions. What happens if you or your partner dies or becomes disabled? Just a “legality”? What happens if you reach a point where you are deadlocked over a decision? Just a “legality”? What happens if you or your partner want to sell out his or your interest? Just a “legality”? What happens if one of your family members wants to join the business? Just a “legality”? What happens if one of you wants to go into debt and the other doesn’t? Just a “legality”? Do you find these questions troubling? You should. At the typical organizational love fest, well-meaning business people too often dismiss these questions as just “legalities” to be taken care of later. This is just like taking your boat out into the ocean and checking your fuel supply later.
I was approached a few of years ago by a group of 10 guys, one of whom was a very good friend and still is, who wanted me to invest in a food company they were forming. My investment was to be $50,000 for which I would get 10 percent of the limited liability company (LLC). I looked at their first draft of a business plan, consulted with some people in the industry, and concluded that it looked like a good investment. “Okay, I’m in,” I said. “Just send me the Articles of Organization and the Operating Agreement” (the minimum documents for an LLC). “Well,” said my friend, “you have to understand that these guys are used to doing business on a hand shake. They just want to get things operating and worry about the legalities later.” The inevitable occurred. There was constant squabbling about investing in new equipment and inventory versus taking dividends from the start. This is, and can always be, a major stumbling point. None of the investors were kids. Some of them thought that the idea of plowing back money into the business wasn’t the way their money should work, and taking out some of the profits just seemed like a good idea. To complicate matters, there was never an understanding about who was to do what. Who was going to be the boss and make important decisions every day without getting an opinion from the rest of the gang? The business totally failed after about two years. I’m glad I passed it up, saving myself $50,000 as well as my pal’s continuing friendship. I never tell someone “I told you so” because I believe only a smartass would say that, especially to a friend. But my friend volunteered, “You told us so.”
An oral agreement isn’t worth the paper it’s written on
Legally, not all contracts have to be written. Some contracts must be in writing, such as a contract to sell real estate. The law that requires some contracts to be in writing is known as the statute of frauds, and it dates back to seventeenth-century England. In the United States, the statute of frauds is part of the Uniform Commercial Code. Contracts that must be in writing to be valid include marriage contracts, real estate contracts, and contracts that cannot be completed within one year. I won’t review the entire law here, but this is what you need to know about contracts: if an agreement is important, get it in writing, whether or not it is required by the statute of frauds. What is important? Don’t bother trying to answer that question: get every agreement in writing. After buying a new house, I was approached by a couple of guys who provided swimming pool cleaning and maintenance services. They told me they would open the pool within a couple of weeks of Memorial Day; they would clean it once a week; they would put in chlorine and other chemicals as required; they would clean out the intake traps and keep the lines clear; they also said that they would close the pool within a couple of weeks of Labor Day; and, finally, they would put on the winter cover. The costs might vary, they told me, depending on circumstances like weather and chemical needs. Lots of information, yes? I said that sounds fine; just prepare the contract so I can review it. The chief guy looked at me as if I had just insulted his mother, put out his hand, and said, “Here is my contract.” They didn’t get the point—or the job. If all of those words can be spoken, they can be written. Compare this to a contractor who did work on our vacation house in Pennsylvania. Every now and then, I would ask him to perform some tasks, such as installing a couple of new electric boxes, repair a portion of the deck, install a new window, and any number of those things you want to be done to your property. Every single thing I asked him to do would be followed by a fax from him, noting exactly what was to be done, the price, a signature line, and date. The first time he did this, he said, “You’re a lawyer, so you probably know a lot more about this than me.” “No,” I said, “You are doing precisely what any lawyer would tell his client.” This was a contractor who never had to waste his time, or mine, discussing misunderstandings or memory lapses. If this seems like simple common sense, it is. Why doesn’t everybody do it?
“But I distinctly remember”
These words are often the prelude to a lawsuit. Elephants may have great memories, but elephants can’t form contracts and start businesses; so unless you and your partner-to-be are elephants, consider this: your recollection of something in the past, just as that of your partner, is subject to human frailty. Any business lawyer can tell you that there are occasions where each opponent appears to be telling the absolute truth, but each version is completely opposite. And, in truth, if each opponent took a polygraph test, both would pass because each one sincerely believes his or her version of the agreement. Contracts don’t mean that two people distrust one another. It means that both people prefer to be guided by good planning and the written word rather than by their ability to argue.
Contracts keep friendships
“But counselor, this is my brother (sister, best friend, etc.). We don’t need a written contract.” Any good lawyer will advise that a written contract is especially important for people who are related or close friends. Suppose two brothers have a serious disagreement down the road. If one is able to present the business agreement to the other, he can say, “Didn’t we cover this at paragraph 9, section 3, when we started the business?” Remember the story I told about the 10 friends who started the food company? I understand from my friend that the individuals who formed the business are no longer friends. A well-written contract will cover the vast number of possibilities that can come up in a business. Of course you still have to practice what I call the art of partnering.
Copyright © 2012 by Russell F. Moran
The writer of this article is the author of The APT Principle: The Business Plan that You Carry in Your Head, Coddington Press, 2012. Parts of this article have been excerpted from the book.