Founder's Rulebook: Business Ownership Agreements and Why You Need One

What happens if your business partner wants to sell their shares to your competitor?

What if they get a divorce?

If you don’t have a written ownership agreement, you’re about to find yourself in a costly legal battle.

Too many multi-owner businesses operate on handshake deals with no forethought. For a time, many businesses will operate smoothly on goodwill and compromise alone.

But when an unexpected life event occurs—a death, divorce, or a simple change of heart—that goodwill can evaporate overnight.

Creating a business ownership agreement is one of the most important things you can do to protect the value of what you created in your business.

This guide breaks down what a business ownership agreement is, what it does, how it protects your investment.

But before we discuss the legal details, let’s look at why it is a good business decision.

The business case for ownership agreements

Before we dig into what an ownership agreement is and how it is useful, let’s first recognize that using a written ownership agreement is a good business decision.

Whether you should use an ownership agreement really isn’t a legal question. It’s a business decision with legal effect.

Smart business leaders use ownership agreements because they recognize it as an effective legal tool to protect their investment and what they build.

If you really believe that your business has potential, that it will grow, that you may sell it one day and cash out, act like it.

Do you really think the best entrepreneurs in the world don’t protect their investments with legal tools like an ownership agreements?

What is a business ownership agreement?

A business ownership agreement is a contract.

It sets out the rules of the relationship between the owners of a business.

Think of it as an official rulebook for the way the owners interact with each other.

There are a few different types of ownership agreements depending on the type of business structure you are operating:

1. Shareholder Agreement: An agreement between the shareholders of a corporation that governs the rights and obligations to one another.
   
   
2. Operating Agreement: A comprehensive agreement that governs the relationship between the owners of an LLC, plus the rules that govern the operation of the LLC from a business perspective.
   
   
3. Partnership Agreement: The agreement between the partners in a business partnership.

The core purpose of these contracts is to formally define the rights, responsibilities, and relationship between the owners of the business.

The three pillars of a business ownership agreement

There are three general topics that a well-drafted business ownership agreement should cover.

1. Day-to-day operations

The most frequent source of friction between partners isn't a major crisis, it’s disagreements about the daily operations of the business.

A clear co-founder agreement eliminates friction by defining:

• Roles and responsibilities: Who is responsible for what specific functions (e.g., sales, finance, operations)?
  
  
• Decision-making authority: How are decisions made? What requires a simple majority vote versus a unanimous vote? This prevents arguments over who has the final say on hiring, spending, or strategic shifts.

2. Framework for major decisions

As a business grows, the owners will inevitably face critical decisions that go far beyond daily operations.

When partners have different visions for the company's future, it can lead to a paralyzing deadlock, especially in a 50/50 partnership.

An ownership agreement forces a conversation on these high-stakes issues before they become contentious, creating a clear process for handling questions like:

• Profit distributions:How much profit should be reinvested into the business versus being paid out to the owners?
  
  
• Taking on debt:Does the company take out a major loan to fund expansion?
  
  
• Bringing in new owners:Do we accept a new investor or partner, diluting our ownership?
  
  
• Selling the company:What happens if one owner receives an offer to sell the business, but the other doesn't want to?

Instead of leaving these to a future argument, the agreement can establish voting thresholds, such as requiring a unanimous or supermajority vote for major decisions.

More importantly, it can include a deadlock resolution mechanism.

A common example is a "buy-sell" or "shotgun" clause, where one partner can offer to buy the other's shares at a specific price. The other partner must then either sell their shares at that price or buy out the first partner at the same price.

This pre-negotiated process ensures a fair and definitive outcome, preventing a single disagreement from jeopardizing the entire enterprise.

3. Protection from the 4 D’s

Some of the biggest threats to a multi-owner business come from personal life events.

A buy-sell agreement, which is a key component of any ownership agreement, provides a clear plan for handling the 4 D's:

• Death: If an owner passes away, the agreement dictates what happens to their shares. Typically, it gives the company or the remaining owners the right to buy those shares from the estate, preventing them from passing to a spouse or heir who has no interest in running the business.
  
  
• Disability: If an owner becomes permanently disabled and can no longer contribute, the buy-sell provisions provide a mechanism for an orderly buyout.
  
  
• Divorce: A buy-sell agreement can prevent an owner's shares from becoming a marital asset subject to division in a divorce, thus stopping an ex-spouse from suddenly becoming your new business partner.
  
  
• Disinterest: If an owner wants to retire, quit, or is terminated for cause, the agreement outlines the terms of their exit, including the price and payment terms for their shares.

When should you create the agreement?

The answer is simple. At the very beginning.

Putting together a comprehensive shareholder agreement, operating agreement, or partnership agreement is one of the first things you should do when forming the company.

The process forces critical conversations while everyone is aligned and optimistic. Trying to negotiate these terms after a dispute has already erupted is nearly impossible and exponentially more expensive.

For example, it may cost $5,000-$15,000 to have a comprehensive ownership agreement created, depending on the number of owners and the complexity involved.

But it could cost $100,000 or more to litigate an ownership dispute down the road.

A good foundation

An ownership agreement is a strategic, well-thought out foundation to a business partnership.

It provides structure and clarity needed to navigate the inevitable challenges that come with growth.

Most importantly, it creates a greater degree of predictability when the future is anything but.

If you are starting a new venture or need to formalize an existing partnership, our team can help you build a strategic legal framework tailored to your unique situation.

Click the button below to schedule a consultation today.

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Disclaimer: The information contained in this article has been prepared by Small Business Legal Solutions LLC for general informational purposes only. Nothing in this article is intended to constitute legal advice on any subject matter. The materials in this article are not intended to and do not create an attorney-client relationship. Do not act or refrain to act based on any information contained in this article without first personally consulting with an attorney. Every circumstance is different and must be judged on its own merits.