Work together at the outset to address the important structuring issues in your business

Mary and Sally joined forces a couple of years ago to launch Cool Cupcakes, an upscale cupcake-only bakery. The fictional pair have been best friends since kindergarten and saw this as a dream come true. Mary has the baking and creative skills and is in charge of the day-to-day operations. Sally’s got an accounting background and is in charge of the business side of the bakery.

Financially, this bakery’s doing quite well but trouble is brewing. Mary’s absolutely exhausted and she doesn’t think it’s fair that she and Sally are taking the same paycheck out of the business. Mary feels like she’s doing all the work and that she’s not getting compensated fairly. Sally doesn’t see any problem with this financial arrangement. After all, Sally invested all her savings ($350,000) to start this business so she thinks it’s only fair that Mary put in some ‘sweat equity.’

Besides, Sally has grand plans for their business. Now that Cool Cupcakes is really starting to take off, Sally’s ready to open two new stores and has plans for a national franchise down the road. But Mary’s only interested in this one store.

The more they discuss it, the nastier things get. Sally has threatened to use Mary’s award-winning cupcake recipes and expand the line of bakeries on her own. Mary has threatened Sally with a lawsuit if she steals her secret recipes.

What went wrong here — what could Mary and Sally have done to avoid these Cupcake Wars? It’s simple. They needed to work these issues out together before they started the business.

When a business is owned by two or more partners, they need to take steps to minimize the potential friction in their joint business. (Although referred to here as ‘partners,’ this includes co-owners in an LLC, corporation or any other entity). And if the time comes for the partners to part ways, they need to have a mechanism in place to do just that.

Money. The business owners need to clarify up-front exactly how the money will be handled so everyone feels they’re being treated fairly. How much money is each owner required to contribute as up-front capital? What percentage ownership will each have? What happens if the business needs more money than anticipated? How will the money be distributed to the owners- based solely on percentage ownership interests? Based on capital invested? Based on services performed? There’s no right answer to these questions. But one thing’s certain — failure to nail down these issues before the business is launched is a recipe for disaster. Nothing sours a business deal quicker than a partner who feels that he or she’s being treated unfairly.

Management. When a business has only one owner, it’s easy to see who gets to make all the decisions. But when a business has two or more owners, they need to be clear at the outset how the business will be managed. They also need to figure out up-front how they’ll deal with any disputes that do arise.

At Cool Cupcakes, Sally wants to open a new location but Mary’s against it. There’s a deadlock on this decision which could very well lead to a gridlock in the business. A properly structured partnership agreement should include a dispute resolution mechanism to deal with problems like this.

One approach is the put/call method in which one owner buys out the other to resolve a deadlock. Let’s assume there are two equal owners in the business and a deadlock occurs. One owner offers to buy out the other at a purchase price she sets based on her valuation of the business. The other owner can accept the purchase offer and sell her half of the business for that price. But she also has the option to buy out her partner at that same price. This approach encourages that first owner to make a reasonable offer to buy out her partner. Otherwise, she runs the risk that her offer will be turned against her. I think of this as the ‘Twinkie’ approach to a buy/sell. You remember — two kids plan to share a Twinkie and to be fair, one kid cuts the cake and the other chooses which ‘half’ to take.

Moving On. Life happens. People can die or become disabled. They can simply lose interest in the business or decide it’s time to ‘move on’ to a new adventure. If this happens in a jointly owned business, the impact on the business and on the other owners can be huge. We can’t prevent such things from happening but we can plan ahead for them.

The business owners should address these issues up-front by providing a mechanism to buy out the interest of an owner who’s no longer actively involved in the business. If the triggering event is death or disability, provision can be made for the company to acquire life/disability insurance to fund the buy-out. For other triggering events, the purchase price can be payable over a period of time to ease the impact on business cash flow.

If you’re planning to go into business with friends, colleagues or even relatives, make sure you all work together at the outset to address the important structuring issues in your business. By doing this, you’ll be required to focus on the areas that are most likely to create friction, or worse, deadlock in your business. This way you’re more likely to be part of a successful business operated by owners who respect each other and continue to get along.

Judy Gedge is assistant professor of business law at Quinnipiac University School of Business and is a member of the Advisory Board of the Connecticut Small Business Development Center.