By Matt Formeller, Founding Member and LWCN's SME on Law
As a corporate attorney, I see my fair share of business owners and partnerships trying to manage every aspect of their respective businesses. I understand starting lean and operating with an intent to keep your margins wide. However, all business owners share a common problem: we don’t know what we don’t know.
Sometimes relationships are conceptually straightforward; sometimes agreements with third parties aren’t complicated in theory. Yet it’s important to make sure that those agreements and relationships are properly memorialized.
A now retired corporate attorney used to often tell me, “we don’t draft contracts for the good times.” When parties have a disagreement about who was supposed to do what we look to the plain language of the relevant contract. If the agreement isn’t properly memorialized in a written agreement - we are compelled to interpret the agreement (i.e., what the parties thought the agreement was at the time the deal was made). This can lead to undesired outcomes, large expenditures of time and resources, and broken relationships.
A simple case study
Take, for example, George and Sheila. George started a membership-oriented business. Sheila approached him with an offer; she wanted to provide him with $150,000 in exchange for 20% of the company’s common stock (a valuation of $750,000) which George viewed as undesirable as he had previously accepted $300,000 from two previous investors in exchange for 10% of the company’s common stock (a valuation of $3 million).
Sheila reframed her offer: she didn’t want to simply sit as a passive investor like the other two; she wanted to be an active participant in the business’ operations. This made the offer much more enticing to George. The parties came to an agreement and decided to draft their own agreement, sans attorneys, whereby Sheila was to pay her capital contribution according to a simple schedule. They agreed the additional expenses of attorneys didn't need to be incurred since the agreement was uncomplicated and they trusted each other.
After some time, Sheila stopped paying George, leaving around $50,000 of her capital contribution unpaid. She also informed George that she no longer desired to assist in running operations in any capacity. She claimed that her $100,000 should entitle her to 13.3% of the company’s equity because she paid 2/3 of her capital contribution.
Pay me now, or pay me later
While Sheila's contention seems unfair and incorrect – her position will likely win out should it be tested in court. The contract wasn’t properly drafted, it didn’t mention Sheila’s obligation to perform services to the business, and it didn’t contemplate the foreseeable scenarios in which Sheila would not hold up her end of the deal. Now, George needs to retain an attorney to untangle the mess and attempt to resolve it. Had the parties invested in legal counsel from the start, the transaction documents would have been properly drafted and the parties wouldn’t be stressing about a potentially escalating (and costly) legal dispute.
The hard learned lesson
If you’re navigating through a minefield with a blindfold on, wouldn’t you rather take a field guide’s hand who knows where all of the mines are located?
Matt Formeller is a partner and co-founder of Formeller & Formeller, a corporate law practice in Chicago. For the fifth year in a row, he has been named an “Emerging Lawyer” in Illinois for Closely & Privately Held Business Representation as well as Commercial Litigation, a recognition earned by the top 2% of attorneys in Illinois under 40 years old in their areas of practice. Matt received his Bachelor’s Degree in Business Administration from Illinois Wesleyan University and his Juris Doctor from DePaul University College of Law.