Wednesday, August 4, 2010

"The Magna Carta of Every Business"

[This missive is being reposted by request.]

To anyone else in the Lower Garden District of New Orleans, Louisiana, the eleventh of June might have been just another ordinarily hot day, but for a trio of young ladies, it was one of the most exciting days of their lives. Early that morning, they gathered together with big smiles on their faces and even greater hopes in their hearts, as they readied themselves to take a series of united steps into the future. And it all began with a few strokes of an ink pen. Before a very studious notary, each of those ladies willingly joined her compatriots in the formation of a new corporation. Perhaps, to some, there was nothing uncommon about such an action, but for these three, it was a demonstration of trust and a bold gesture that opened the doors to that promising future, one wherein they made the terms and controlled the range of their own success. Indeed, for these young ladies, it was a proud moment, because they knew that, within a few hours, their dream would become reality; their legal documents would be fully filed with the proper governmental bodies, and the lease on the corporation's first property also would be signed, making them business owners.

Once the notary affixed his stamp to a few of those documents, one of the ladies, the principal shareholder and manager-designate of the new enterprise, turned to me. “Thank you so much,” she uttered. She would say those same words a few more times during the day, but each time that she did, I dutifully thanked her for turning to Axiom Strategy Advisors for help.

In all fairness, none of those women would ever have to thank me—nor should any of the other new entrepreneurs that I’ve helped this year, or in the years prior. That’s because this is, foremost, something that I love to do. I have become quite passionate about helping new entrepreneurs transform their passions and ideas into viable businesses. Even as the service scope of my consultancy skews decidedly to middle-market clients, I still stress the importance of guiding new business owners, by working with them to model these ideas for revenue generation, by helping them to choose and register the appropriate business structures, and by providing them with the advice needed to head off the early pitfalls of business. Sure, this can be a stressful process, but I consider it to be quite gratifying. After all, Axiom Strategy Advisors, LLC, would not exist, were it not for a spate of small-business clients who fueled its growth in the beginning. Consequently, no matter how quickly or how broadly the consultancy grows, AxSA will always harbor an allegiance to small businesses.

There is a second reason for my devotion to new business owners. It is rooted, quite honestly, in the grim statistics that predict their failure. Most new businesses—fairly over sixty percent of them—never make it to profitability. The reasons can be quite vast, ranging from poor locations to undercapitalization, from mismanagement to ineffective marketing, and so on. But, to me, a consultant, most of those reasons coalesce into just one overarching reason: these challenged business owners don’t get all of the help they needed, and so, they failed to plan strategically. To be sure, a variety of small-business resources do exist for entrepreneurs. They can always turn to the SBA, but they will find that group is largely set up for debt financing, not advice. Meanwhile, groups like SCORE or a local economic-development agency can provide general guidance, but they, too, are not set up to delve deeply into the specificities of an entrepreneur's operations. And that leaves new business owners with the choice of going with costly accountants and lawyers or going with experienced management consultants. Naturally, no one would discount the roles for accountants or lawyers, but a consultancy like AxSA provides the objective, boots-on-the-ground perspective—an outsider’s look inward, so to say—on the business, the marketplace, the workflow processes, the culture, and the numbers that can help entrepreneurs see farther and go further when it comes to strategic planning and tactical decision-making. Therefore, my desire, as such a consultant, is also to help as many new businesses as possible dodge the prospects of becoming part of those ugly statistics.

Of course, this post was not meant to be a sales pitch for Axiom Strategy Advisors, LLC. In actuality, my words were only intended to help frame the importance of my topic, which is a look at the promise and perils of partnerships. And with that said, we will return to the case of our three young ladies in the Lower Garden District...

Among the documents signed by the trio, on that warm Friday morning, was an operating agreement. Some of you may know it by other names, i.e., a shareholders’ agreement (or the by-laws), a founders’ agreement, or a partnership agreement. And yet others may not know it, at all, which is not entirely surprising. Nevertheless, essentially, these are all the same. An operating agreement is akin to the Magna Carta of every business. It is a written understanding between the founders of the enterprise detailing thoroughly how that enterprise is formed and governing quite precisely how it is to be managed. And for the young ladies entering into this new corporation, it was a must. In fact, interestingly enough, they initially approached the consultancy with the idea!

Going into business with partners can naturally be a good thing for a new entrepreneur. In many cases, partners can bring with them, in exchange for equity in the business, much needed capital and/or talent. If nothing else, it means that there will be someone else tagging along for a very unpredictable journey, someone who will share all of the triumphs and the difficulties. What’s more, when partners seems rightly in sync on the business’s purpose and plans, the added brainpower can cultivate fertile ground for new ideas.

Unfortunately, some partnerships do not go so well. Or, as Jake Duncan would say, “It can turn into a hell of a mess!” He would know. His partnership in a tool and dye business ended on a very sour note, but that was not before the bad blood between the partners led to allegations of thief, litigation, and the ultimate closure of the business. Like most failed partnership, the Duncan partnership did not plan holistically for their own success, and they had never devised an operating agreement setting any parameters for running the business. In short, there was never a clear delineation as to who could make day-to-day decisions, who could spend what, or even how the business could be sold when one person wanted out.

It might not seem important in the outset, but such an agreement is vital to the governance of an enterprise. In fact, when dealing with two or more would-be members, partners, or shareholders of a new enterprise, it has become a common practice of this consultancy to stress the importance of a carefully-crafted operating agreement (or concise by-laws, in the case of a corporation), if only to govern the possible success of the enterprise. Even still, one would be amazed by the number of people who, after hearing the fullest explanation, profess to not seeing the point for such a document. Nevertheless, as has been the case with frightening consistency, only a matter of time passes before issues do surface that would have been easily mitigated by such an agreement. Fortunately for AxSA, the three young ladies starting out on that warm June day understood the need for this document well in advance of asking the firm to craft it for them.

There are many intricate aspects to an effective operating agreement. It must cover in serious detail everything from monetary contributions to the management of operations and finances, from the roles of individuals to how decisions get made, from succession plans to matters pertaining to the budget, and more. Indeed, it can be an involved document, but that is not a reason to shy away from its use. What’s more, while AxSA promotes the enactment of the operating agreement at the launch of any new business, the firm does concede that this document can be crafted at virtually any point in the business’s life. Yes, basically, there is always a chance for hope.

While a comprehensive operating agreement has a plethora of components, I think that it is important that each of agreement have at least five basic components, and it should consider these questions:

Regarding Equity

Who are the members, partners, or shareholders of the enterprise, and what have they contributed to the enterprise?

How is the equity of the enterprise divided among the stakeholders of the enterprise?

What types of equity classes exist for stakeholders of the enterprise?

Regarding Roles, Agency & Conflicts

Who are the managers of the enterprise? Who are its registered agents?

Can all stakeholders conduct business in the name of the enterprise?

If the stakeholders do play roles in the operations of the enterprise, what are those roles, and who has them?

Are there adequate protections for the minority stakeholders if the managers or majority stakeholders knowingly commit lawful or criminal misconduct in the name of the business?

What constitutes a conflict of interest by any stakeholder or any employee of the enterprise?

Regarding Voting

How many votes will be each stakeholder possess?

What constitutes a quorum?

When will the stakeholders meet to discuss new business?

On what issues will a unanimous vote be required?

How will dispute resolution be dealt addressed?

Regarding Budgets & Finance

How will the fiscal and project budgets for the enterprise be decided?

Do managing stakeholders or registered agents have singular authority to make large purchases, or will such purchases be vetted through all stakeholders?

Who will determine the compensation rates for new hires?

What is the protocol for selecting and employing professional services?

Will the enterprise be allowed to incur debt? If so, who has the authority to seek it?

Regarding the Exit of a Stakeholder

Will the enterprise carry life insurance on any managing stakeholders?

What is the succession plan for the enterprise?

If a stakeholder desires to leave the enterprise, will the other stakeholders have the right of first refusal? If so, what is the nature and timeline for the process?

Again, to be sure, there is a lot more to an operating agreement than these points, but I felt these to be critical enough to consider here. Also, all of this might seem like heavy material to entrepreneurs who would otherwise be eager to simply start their new enterprise, but I would argue that coming up with the right agreement is an essential part of the planning phase for your business. Working out such terms might be far more difficult down the road. What's more, while one might hope that every partnership can work out on its own, the truth is that many do not, and documents like these can help keep order and protect the interests of the stakeholders when those relationships fail.

Three young ladies celebrated on the second weekend of June. Their joy came from the fact that they were stepping out on their own, taking risks to build their dream, not someone else's. And with that joy came solid piece of mind, the kind that reinforced their trust in one another and their belief in the stability of their new enterprise. The joy, understandably, attested to the fact that they were new business owners; the piece of mind, quite obviously, attested to the strength of the agreement that they made with one another.

So where is your operating agreement?


John said...
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L. Oubre said...
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Digger in LV said...
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Clay said...

I appreciate it when you guys do these headline shows. It's cool to hear your impressions on current events. Our world is so strange and you guys man it easier to understand.

Digger in LV said...

I'd like a Maybach! Sean, will you be my daddy???

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