In any business arrangement it is important to ensure the legal relationship between the various interests is carefully defined and documented.
In the Hollywood blockbuster movie, The Social Network, the undefined relationship between co founders Mark Zuckerberg and Edwardo Saverin led to litigation which fortunately for the parties involved led to a undisclosed settlement. Mr Saverin initially had ownership of 24% of the Facebook company which was subsequently diluted to below 10% after a change in the position between the two co-founders. With an implied value of Facebook in October 2007 of around US$15 billion a 14% interest represented US$2.1 billion, certainly enough money to dispute about.
Put in the Australian business context there are various legal frameworks by which businesses are operated whether it be a company with shareholders, a company acting as trustee of a unit trust with the business interest holders owning units in the fixed trust, a partnership of companies acting for discretionary trusts or a simple partnership or joint venture arrangement. There can also be special arrangements for capital injection participants, venture capitalists and sweat equity participants. In each of these structures, it is possible to ensure certainty between various holding interests by putting in place a legal relationship agreement such as a shareholders agreement, unit holders agreement, partnership agreement or joint venture agreement setting out in legally enforceable terms who owns what and what the relationship will be. Senior employee capital interests can be regulated and secured by an employee share scheme. The purpose is to ensure certainty in defining what the legal relationship between the various interests is thereby minimising conflict and energy sapping litigation.
Certainty is in the interest of both major and minority interests. For majority interests (primary business owner or entrepreneur) it ensures that only the interest intended to be granted to minority interests is effective and enforceable. It reduces the risk of subsequent litigation which draws attention away from the operation of the business.
From the point of view of a minority interest it ensures that the ownership interest they think they have is properly defined and enforceable.
Where business owners have combined forces to operate a business or venture together for their mutual benefit having a legal relationship document setting out what the parameters of their rights and obligations are provides a framework by which they get on and make money by concentration on working the business venture. It is healthy to negotiate an operating framework so the various interests know what to expect. When going into a venture it is always easier to come up with a framework by which disputes are resolved before any such difficulty arises. This will allow business owners to negotiate and come up with a solution to resolve friction which they are comfortable with before dispute arises.
The legal relationship agreement can define what the equity interests are, what decisions in the venture must be unanimous or otherwise, what the obligation for making capital contribution will be, what the obligations for contributing to liabilities will be, how much income should be retained for working capital, dispute resolution mechanisms, insurance arrangements and many other issues.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.