Founders of privately owned companies somehow always find creative ways to create conflicts among the owners – or would-be owners – of their business ventures. Our attorneys have seen our fair share of disputes among the owners of private partnerships, corporations or limited liability companies. Some disputes arise from a misunderstanding over a particular person being considered a partner, shareholder or member because of the short-term and transient role she may have played in the company’s founding and early success.
One common scenario is when family members or friends help the founders of a new venture build a business from scratch, and expect compensation in the form of an ownership interest for doing so. They delay the day, however, when they first raise the issue and then seek to negotiate the terms of the agreement by which they purchase, or receive in exchange for their sweat equity, an ownership interest in the company.
Another common scenario is the blurry relationship that arises between a third-party financier who provides an infusion of much-needed capital into a privately held company, and that person’s on-going role in the company after the financing closes. The urgent need to secure financing to sustain the company inevitably postpones the discussion between the financiers and the company’s existing owners about the role, if any, the financiers will play going forward. Sometimes financiers want to take an active role in the company, whether they know anything about the business or the industry in which it operates, or not. Sometimes they simply want a role in the company to baby sit their money. In both of these scenarios miscommunication – or no communication – can create an “accidental” partner, shareholder or member of your company that you never expected to have.
What happens when a demand gets made for a share of the company’s profits and the issue of ownership becomes contested? There are always two sides to the story. There are situations where a company will claim a promoter or employee never had any equity rights in the company’s stock. Yet that same company has created corporate records, advertising literature, websites, social media posts, and the like that state quite the opposite. From the perspective of the company and its other shareholders, the promoter or employee has no ownership rights. On the other hand, the promoter or employee believes she is entitled to a share of the profits because of her performance or representations made to her by one of the founders or executives. A court, whose job it is to resolve the dispute based on the evidence presented, has the task of figuring out who is right and who is wrong. The cost of litigating such a dispute can be substantial. The cost of litigating and losing, even more so.
There is a common misperception that a party claiming an ownership interest in a corporation, partnership or LLC has no rights when the company does not issue stock, does not formally issue a membership certificate, or the aspiring member, partner or shareholder never signed the operating, partnership or shareholder agreement. These assumptions are frequently incorrect. There are several legal doctrines that have developed over the years to protect people who have been promised an interest in a partnership, corporation or LLC, and have relied on those promises to their detriment, even where the company never formally issued a stock certificate or membership certificate.
If a negotiated resolution cannot be reached, these cases can wind up being quite expensive to litigate because very often the question of whether such an interest exists will be left to the judge or jury to determine. Regardless of the press of time that your new business venture may seem to be under, it’s important to properly document the relationship between promoters or employees and the company or partnership to avoid a future lawsuit. It’s equally, if not more, important to document the relationship between the company and third-party financiers because if they do not receive all of the consideration owed for the funding – including their believed ownership stake – they may call in their note and your company could lose the benefits of the financing and find itself without adequate capital to continue to operate. Proper documentation is essential to avoid the event of the “accidental” partner, shareholder or member, and the lawsuit that is almost certain to follow. Make sure you work with skilled attorneys whose counsel you trust, know how to prepare the transaction documentation for you, and can provide it to you in a timely manner.