Common Disputes with Business Partners and How to Avoid Them

Starting a new business with your friend is exciting but as the saying goes, a friendship founded on business is better than a business founded on friendship.  Here are common disputes with business partners and general methods for avoiding them.

1.  Fraud, breach of fiduciary duties, misappropriation of funds.

How to avoid
  • Know your business partner well.
  • Get references from other people who did business with the person.  
  • Check the business history, when the business was formed, and who are the other owners or related parties.
  • Check for any judgments or creditor claims. 
  • Establish accountability and transparency in the management and put it in writing (in the operating agreement, partnership agreement, bylaws, or other applicable documents).
  • Keep track of the funds and check the bookkeeping and accounting records regularly.
  • Check your potential business partner for any suspiciously hidden or transferred assets. 

2.  Disputes over assets and exit procedures.

How to avoid
  • Discuss and clarify, in writing, who has what share in the business, how the profit will be distributed, and what each partner's roles and contributions are.
  • Memorialize it.  For LLC - have an operating agreement.  For partnerships - have a partnership agreement.  For corporations - have bylaws, stock certificates, stock purchase agreements, written consents of shareholders, and other necessary documents.
  • Outline the exit plan in writing.  Make sure the documents clarify the procedures for exiting the business, and how the ownership interest is bought out, distributed, paid off, and transferred.
  • Clarify and memorialize the ownership rights and the terms of use for the company's assets, such as patents, copyrights, trade secrets, and real property, 

3.  Disputes over control, business decisions, and takeover.

How to avoid
  • Establish a healthy communication atmosphere and boundaries.
  • Have insurance coverage for business and director & officer liability. 
  • Memorialize the share transfer restrictions, the voting procedures and powers, the officers and managers' duties and election procedures, dissociation procedures, the extent of fiduciary duties, and many other things.

4.  Contractual disputes.

How to avoid
  • Have the business arrangement carefully structured and consult with a CPA regarding the tax consequences.
  • Research common risks associated with the type of business activities and describe in the contract how this risk is allocated.
  • Draft the contract while still negotiating its terms, not after.  There are many terms that are usually not discussed during negotiation but get inserted in the contract after the deal is "done".
  • Draft the contract and check it for enforceability, read the contract carefully and consult with an attorney before signing. 
  • Consider requiring a guarantor agreement where possible. 
  • Consider requiring from the potential business partner proof of sufficient funds and sufficient insurance coverage when doing business together. 
  • Check for any other contractual remedies and damages. 

Even with all due diligence and caution, no business is dispute-proof. In each business dealing, it is best to assess your risks in balance with the business perspectives.
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