Kaila Law Group has many clients who want to invest in their friends or family members’ businesses – either to support their venture, or with hopes of a return, or both. We always remind our clients who are considering investing that there are a few tips that can help smooth the way to a successful business collaboration.
Tip 1: Try and stay objective. Better yet, hire someone to stay objective for you.
When it comes to business, it’s extremely important to stay objective – and when it comes to people we know personally it’s easy to let our personal feelings about them get in the way. Before entering into a business relationship with anyone, it is important to consult a professional who understands and can explain to you any potential liabilities to which you may be exposing yourself. You may be thinking to yourself “I’ve known Bill for years, and I trust him – why do I need to hire a lawyer?” It’s not that you each your own attorney – usually, both parties may consult the same lawyer. It is merely essential for each party to consult with someone who can determine what each wants and reduce it down to a legally effective agreement.
Here are some of the specific issues an attorney can address:
- Which entity (i.e. partnership, LLC, LLP) would best suit your business?
- How to limit your liability from debts incurred by the business.
- Defining clear roles for everyone involved – for example, determining whether investors have any managerial authority in the company.
- Defining the investment – is it a loan to be paid back? Is it an equity investment? Does it create a partnership-in-fact?
- How to avoid potential litigation should a conflict arise – an operating agreement drafted by an attorney can include procedures by which a business can internally resolve conflict without having to resort to potentially costly litigation.
Tip 2: Get it in writing
We know that you really trust your potential business partner, you’ve known him forever, he’s a good guy … no matter what, you should get the arrangement in writing, signed by all parties. Again, that brother-in-law may be the most trustworthy guy you know, but people may gloss over details when moving forward with a business plan, or the details may be forgotten over time. An attorney experienced in business formation and start-ups can alert you to such issues, and ensure that each party is fully apprised of the agreement into which they are entering.
Tip 3: Make sure you understand exactly what you are getting in to.
Many people start business ventures with friends or family without fully understanding what is involved, both financially, and logistically, in investing in a business venture. If you’re not sure what is really involved, consulting an expert can give you a much clearer sense of what the potential upsides and downsides are to the investment. We usually recommend that people consult a business attorney and a CPA who can work together to limit the investor’s liability and protect against potential tax or legal pitfalls. We sometimes put our clients in touch with financial advisors who can review clients’ financial plans and portfolios to determine whether the investment meets their financial goals. This information will help you more clearly evaluate whether the investment makes sense to you, both financially and personally.
When personal and professional relationships are mixed, you need to take extra precautions to ensure that both you and your assets are protected. The fact that you know someone or that they are a family member has the potential to cloud your judgment. Consulting an objective third party who has experience in business formation and other matters is the best way to ensure that you proceed prudently and without exposing yourself to more risk than you intend.