Being asked to join a new or existing business is always an exciting prospect. You’ve been invited to contribute to something that could be great, bringing with it all the financial success and the pride that comes with knowing you contributed to its success. But before making your contribution, you should ask yourself and your prospective partners many questions. While every investment has some risk, the more you know, the better you can protect yourself against those risks.
First and foremost, of course, you should evaluate whether the idea or product is a good one that will serve potential customers’ needs. But there are other questions that are just as important, relating to your relationship to your new business partners. These questions include:
Is the company being run properly? Any investor should examine the books and records to see if the company is doing well and handling its income, expenses, and obligations correctly, including meeting its tax obligations. You may find the business is struggling and your investment will help put it back on its feet. While that might be an acceptable risk, you should know before investing so you can make an informed decision.
What am I expected to do for the business? Are you merely a lender? An owner without any expectation that you are to do any work? Or are you expected to contribute your time or skills? If so, how, if at all, are you compensated?
Do I have any say in how the business is managed? How is voting done? Many persons think joining a small business means they will have equal say in the management and operations of the business. That is not necessarily true! In a corporation, shareholders do not have management rights just because they are shareholders. The opposite is generally true for partnerships. LLCs are often somewhere in between. Which leads to our next question:
What type of entity is this? Is it a corporation? An LLC, a partnership? Something else? The answers to these questions will reveal a lot of what is expected of you.
If an LLC, is there an operating agreement? An operating agreement is critical to the operations of an LLC, particularly one with multiple members. The operating agreement will state how the business is managed, whether by the members (the “owners”) or by a manager hired for that purpose. It also governs procedures for declaring distributions, and how a member may withdraw or be expelled from the LLC. Before investing your hard-earned money, you should receive and review carefully the operating agreement, with the assistance of a business attorney, so you will understand your rights and obligations.
This LLC does not have an operating agreement. Is that OK? While Illinois law does not require a written operating agreement, an LLC without one can result in many misunderstandings and arguments over what the rights and obligations of the members are, which distracts from the operations of the business and can even result in costly lawsuits.
If a partnership, is there a partnership agreement? Similar concerns arise if your business is a partnership. You should carefully review the terms of the partnership agreement for the same reasons you should review an LLC operating agreement.
What can I expect in terms of dividends or distributions? Normally, you join a business in order to make money, so it is important to ask when and how you will receive a return on your investment. Some businesses will pay out profits as they are earned; others will save for reinvestment. Either plan can make sense depending on the circumstances, but you should know what those plans are so you are not surprised.
How does a business owner leave the company? Does he get his investment back? While leaving a business is normally the last thing on an investor’s mind when joining the business, this is a crucial issue. Sometimes things go wrong and it is best for all if the partners go their separate ways. However, it is often difficult to leave a small business with your investment intact, even if it is doing well. The Illinois Limited Liability Company Act does not require an LLC to “buy out” a member who wants to leave, although an operating agreement might. Shareholders of a small business corporation may find it difficult to find a willing buyer of share. And a partnership may need to dissolve altogether. While parties can always agree to terms of a withdrawal, that may well come only after lengthy, costly litigation.
Before signing on the “dotted line,” asking these questions and more will allow you to have greater peace of mind now and avoid serious problems later. Therefore, investors should obtain a company’s financial statements and governing documents and review them with a qualified attorney, so their investment can get off to a good start!