“I own a boat” says someone you are thinking of going into business with. In the next sentence you hear “I also have several investment properties“. Are you impressed?
Our clients were. They entered into business relationships with people who used these exact hook lines. They reel parties into one-sided ventures requiring upfront payments and work in return for vague promises of financial return.
Business structuring and collaboration formation, including for intellectual property (IP), are priority topics. I feel passionate about creating business structures that can be long-lasting for clients. I feel disappointment when businesses fail due to structuring issues.
Why is business structuring a priority?
The priority for structuring decisions arises due to many important factors. Here are some.
- Collaborations. Increased competition require responses via collaborations (eg alliances, partnerships, distribution networks).
- Change. Waves of change require the design of structures that are built to last or can “see” further ahead.
- Flexibility. Globalisation and digitisation works for structures designed to adapt, evolve or scale more easily.
- Law: Changing structures involves legal decisions and financial consequences that are worth anticipating.
How do structuring problems arise?
The problem for people who get hooked starts at the beginning. There’s a common pattern at work, creating poorly structured businesses and collaborations.
- The idea. People in business and entrepreneurs gather and decide to work together.
- The advice. At some stage they see the need for legal and accounting advice to formalise their legal and financial relationship. After an hour or two of consideration by their professional adviser they instruct their adviser to form a structure. It may be a company, a trust, a partnership, a joint venture, a licensing arrangement, a combination of these or something else.
- Signature of a foundational document. Quickly a shareholders agreement, partnership agreement, trust deed, licence or other foundational and constitution-like and legally binding document is brought into existence by signature of it by the parties wishing to form such a structure.
- Filed for possible future reference. For the parties signing them, the foundational documents are largely abstract “legal stuff” which they typically file away on signature. They were drafted to be filed away on signature. Their content does not make them a living document. They were not drafted to include a map, guide or blueprint to develop the venture.
Consider what’s just taken place.
- The missing items. There’s been no creation of documented plans, budgets, cash flow forecasts or other spreadsheets that can be referenced or attached to the foundational document. The strategic and business goals of the venture are not even recorded in a bullet point type business plan.
- The gaping holes. While determining ownership, the foundational document, and whatever other documentation there is, says too little about job roles, financial controls or business systems. It follows there’s no fully considered job descriptions, carefully considered and detailed written employment contracts, and agreed business policies and procedures.
A business structure has been legally formed quickly, allocating ownership to participants, but without practical or operational plans or financials as there’s been only low level customisation of template legal documents. A vehicle has been created without thinking about what the journey will require and without maps.
The professionals engaged to give the advice (typically an accountant and maybe a lawyer) did not consider such detailing to be part of their pre-venture establishment job description. It may be they were simply following strict instructions to just do the minimum basics to start quickly and keep costs down.
What happens if this venture or start-up strikes a problem after “real work begins”? If the problem festers and is allowed to lead to a heated exchange of views this will make it less likely there will be an opportunity to resolve it. The hastily and poorly prepared foundational documents now become obstacles. The parties to it are locked together in ownership, but not in terms of practical details that might help them save, rework or unravel the venture or start-up.
With little in the way of a plan to get out of a mess the disagreement between the parties goes to another stage, outright dispute. Locked in joint ownership the parties enter a civil war with demand letters issued and threats of litigation. Business operations suffer and if not resolved an insolvency professional may be brought in to take over.
While for the original parties the venture is now officially dead, its carcass can continue to cause issues for its founders for months, years or decades. There may be tax office phone calls about unpaid tax, creditor demands, litigation with customers and suppliers and too little left for all of this after assets are divided up, sold, auctioned or thrown away.
I’ve witnessed the pattern of events in dozens of cases. I see it as arising from ignorance, haste or lack of professionalism on the part of people in business and their advisers.
When the cases first reach us the anticipation of the parties is generally that their foundational document (eg shareholders agreement) surely contains the answers to unravelling matters. The parties were consistently wrong on this.
For me structures on the way towards legal disputes or litigation immediately recall Abraham Lincoln’s famous speech saying “A house divided against itself cannot stand“. Lincoln’s speech was before the American Civil War (1861–1865). The war caused a shocking level of loss and damage to human life and property. It was in a sense the first (brutal) modern war. The consequences and national grief were felt for decades by the North and South, if not over a century and to the present day. As confirmed repeatedly even to the current day, civil wars are a nasty business, among the worst types of war, few participants survive them unchanged. So if you are rushing into a business collaboration devote a minute of silence to ponder the American Civil War and those since.
When forming a business structure or collaboration until you work out how to get from A to B do not build or buy a foundational contract or structure eg a shareholders, trust, franchise, licence, deed or agreement.
Do not create a structure when you don’t know the precise function it will serve. Memorise this mantra – if the venture plan is not in writing then it is just plain silly to sign a contract binding all to implement it.