‘Til debt do us part: Planning for your business to not go as planned

Across suburban Chicago, many people will start new businesses this year, and many of them will have more than one owner. While starting a business is relatively easy, keeping it free of conflict is much more difficult. That is why taking affirmative steps to protect both the owners and the company is paramount.

According to the U.S. Census Bureau, some five million new businesses may be started in 2026 in the U.S., about 40% of which will be owned by more than one individual or entity. While optimism is high when a business is launched, recent research by Robert Fairlie of UCLA found that only 33% to 45% of startups survive after five years. A lack of capital is usually the culprit, but many other factors can sink a business such as overestimated demand and ineffective marketing.

Moreover, multiple-owner businesses have additional challenges, which can include conflict between owners. Multiple owners may mean multiple visions and opinions about how the business can and should operate.

However, these types of conflicts do not have to force a business to close its doors. One way to avoid a critical fallout is to have a document clearly defining the rights and responsibilities of each owner that can be relied upon to resolve any such conflict and an exit path for each owner if the conflict cannot be resolved.

Too often, the governing document of the company is poorly drafted or there is no governing document at all, and that is why litigation eventually ensues. We see this circumstance in small businesses owned by two people all the way up to businesses valued in excess of $100 million. A classic example is Facebook, which in its early stages did not have a formal operating agreement — an omission that later contributed to massive lawsuits over ownership and roles within the business.

Why a business prenup?

If a company prepares for the worst — or at the very least, some rocky roads — at its inception, it can avoid the most severe of these complicated situations. A key first step to opening a business should be to create a business “prenup” that governs the business from beginning to end. Depending on the type of business being formed, these are known as operating agreements or partnership agreements.

But just like with a marriage prenup, new owners in the midst of starting an exciting business venture may balk at the idea of creating a document that contemplates the business not going as planned. More likely, they simply may not have the time or resources to create an operating agreement or partnership agreement.

The reality is, conflict usually occurs. It can be something small the owners can resolve on their own, or it can be something that requires referencing the governing documents of the business. But if there are no documents governing the business, the next step is typically to look to application of the law.

When this unfortunate but frequent circumstance comes to pass, clients are often very surprised to learn, for example, that the Illinois LLC Act is intentionally broad and generic. The generic nature of the act is purposeful by the legislature so its provisions can apply to all types of businesses, but also to encourage business-specific operating agreements. The end result is the act is typically of little help to resolve internal disputes without having to at least consider litigation. If the law were clear, lawyers would have a lot less work to do.

The far better approach is to invest the additional time up front to define each owner’s rights and obligations with respect to the business and to delineate a procedure in the event of future disputes. This can save exponential time, money and heartache, as it formalizes an enforceable agreement between the owners in hopes of avoiding significant conflict requiring litigation.

Steps to take when opening

To that end, we strongly encourage all businesses — regardless of size, type, industry or familial relation — to take the following steps at inception:

Create a detailed written agreement, typically a partnership agreement or an operating agreement. Before the business starts, the written agreement should formalize each owner’s understanding of how the business will run, how it will terminate and how each owner can potentially exit. More specifically, the written agreement should, at the very least, clearly outline:

• Facts about the business, including principal place of business and purpose.

• Each person’s responsibilities.

• How decisions will be made and which ones require the consensus of other owners.

• Compensation, including how owners will be paid and how profits or losses will be split.

• How banking will be handled and how often audits will be done.

• Funding, including how much money each owner will put in at the start of the business or where and how additional funding will be generated.

• Dispute resolution, including a procedure to follow when owners disagree.

• Legal title to the business property.

• Termination of the business, including how the business is to be handled at termination or buyout, how its value will be assessed and what happens if a partner becomes incapacitated, passes or retires.

Consult with an attorney who specializes in corporate law and/or business formation to either formalize a proposed agreement, which can originate from something as simple as outlining important bullet points on the back of a napkin, or help draft an agreement from scratch.

• Include in your written agreement a buy-sell provision that outlines the procedure for a person to potentially leave the business including in cases of retirement, disability or death.

• Ensure that all owners sign and date the agreement and make copies of it. In addition, a good practice is always to email it to all owners so everyone has a dated notice of the existence of the agreement that was signed.

The complexity of an agreement depends on the complexity of the business, and attorneys can craft provisions to contemplate as many potential scenarios as necessary. But the first step is understanding the company needs an agreement at its inception that contains provisions outlining the points enumerated above.

Startups are exciting and crucial to the health of our local economy, but only if they succeed. Taking the time to create a “prenup” reduces the risks associated with multi-ownership and, in turn, improves the chances of creating a successful business.

• James Trail is a partner with Ginsberg Jacobs. He represents commercial clients in complex litigation concerning a wide variety of subject matter, with a particular emphasis on real estate-related matters, fraudulent conduct, contractual disputes, construction disputes and commercial workouts.