Q. My friend and I are starting a business together. We have been planning for the last year and are now in the final stages of preparation. Our (life) partners are enthusiastic about our plans, but I’m concerned that my business partner’s relationship doesn’t seem very stable. I worry about what would happen to the business financially if they broke up. I also worry about our IP – his partner knows a lot about our business. We all work in the same small industry and competitive advantage is everything. I don’t want to upset everyone before we’ve even started, but I am losing sleep over this.
A. Your question brings up some good points. Rest assured you are not the first person to be concerned with these risks and most people going into business recognise it is necessary to mitigate them. Therefore, they are usually dealt with as a matter of routine, before beginning a venture and without any harm caused to relationships.
How your relationships affect your business
When a business owner goes through a separation, it can have a big impact on the business.
In NZ, once you are married or have been in a de facto relationship for three years, then your relationship property is generally considered to be owned equally and is divided this way if you separate. Relationship property will generally include shares in a company where those shares were acquired during the relationship. This would include a new business venture like yours.
While the best outcome would be for your business partner to retain all his shares in the event of a separation, this may be difficult if your business grew and the shares became more valuable than the rest of the relationship property.
If your business partner was unable to pay his partner out, then she could take a percentage share in the business or force a sale of her partner’s shares in the company. These outcomes wouldn’t be ideal for any of you.
You could agree up-front with your business partner that if either of you separate, you would each have the opportunity to buy the others’ shares, rather than them being sold or settled to a third party. This could be documented in a “buy-sell” agreement (more on this to follow).
Contracting out agreement
To protect the business, you and your business partner could each enter into a contracting out agreement with your respective partners. These types of agreements dictate how your assets would be split in a separation, rather than being governed by the law which generally requires a 50:50 split.
For example, your agreement might preserve the shares in the business as your separate property, but balance this out by decreasing your share in the remaining relationship property.
This agreement can be done at any time during your relationship, regardless of whether you have reached the “three-year point”.
Separating your assets might seem like a difficult topic to raise, especially if you have been together for a while. However, your partners might also find this beneficial if your business is taking on debt which they don’t want to be liable for.
To decrease risk and uncertainty, shareholders of a private company such as yours often sign a buy-sell agreement before they go into business. This is a legally binding contract that dictates what will happen in events such as separation, death, disability, retirement or any other reason someone might leave the business.
Your agreement might state, for example, that in these circumstances, one partner’s interests must be sold back to the remaining partner at agreed upon terms. Often insurance is taken out by the business at the same time, in case one of the owners is unable to work due to death or disability.
Buy-sell agreements sometimes require each owner to have a satisfactory contracting out agreement with their spouse.
In many industries it is standard practice for confidentiality agreements to be signed. You should make sure that anyone involved in your business, including your spouses, sign these as a matter of routine.
You should seek legal advice and try to finalise these documents as soon as you can. Note that contracting out agreements don’t necessarily last for ever. They need to be reviewed at least every three years and adjusted if your circumstances change.
This article was first published in the New Zealand Herald.