Thousands of New Cannabis Businesses Forming Now
Most Will Make a Serious Mistake
Because it’s so easy to create an LLC online, many people choose a plug ‘n chug boilerplate. Some use the cheapest attorney they can find. This mistake can cost thousands of dollars later. Don’t overlook the importance of your operating and partnership agreements because comprehensive documents can save you from a lot of grief.
If you are entering a business partnership, the odds are that you will experience a fracture within 5 years. Government statistics show the failure rate of partnerships at 70%. That means nearly 3 of 4 partnerships will fail within 5 years of launch. Most partners who come to me for help are in the third year of business. That’s a crucial time as most companies that survive reach profitability in the third year. There is little hope for a business that is still running negative after 3 years unless that business is experiencing very rapid growth.
What happens when internal problems arise? Let’s take away the possible negative events that can shock a business. Partners die. They get sick or injured. Life events demand attention—a sick spouse, for example.
Putting those aside, what happens if you and your partner have a difference of vision? You want the company to expand; your partner wants to stabilize and collect some profit. What happens?
What do you do if your partner gets tired of making $5 an hour and has a big opportunity to work for another company? This happens every day. People get tired of working hard for a future reward they no longer can see. They won’t walk away. They hold on to their stake but grow increasingly dissatisfied with the business. They often stop working.
I recommend that you address this possibility before it comes up. Set the terms for a voluntary exit by a partner. Make those terms very specific and update them annually. What do I mean by specific?
Most boilerplate buyouts call for a process. There are some appraisals, you take the average and that’s the price a partner gets when choosing to leave. So after paying for 3 appraisals, you average them out. Let’s say that average says the business is worth $400,00.0 The remaining partner simply pays $200,000 for 1/2 of the business. Easy, right? Where do you get $200,000???? Is the business worth that when a partner is leaving? There are not many businesses that have $200,000 in spare cash after 3 years.
I like to set an internal buyout figure in advance. Let’s say we agree on $100,000. The business might be worth $500,000 but we’ve agreed that if a partner leaves voluntarily, they get $100,000. There’s an incentive to stay in! But what if an outside party wants to buy the entire company? No problem, sell it for whatever price you wish. The voluntary exit price is for internal use only.
Next, we set the terms. Since the business probably won’t have cash if someone wants to leave, we can include payment terms in the agreement. $100,000 to be paid at 3% interest over 5 years. There, done.
Now, every year you need to update the number. If you cannot agree to a new figure by April 15th of the new year, the figure increases by 5% each year unless a new number is set by agreement.
Should a dispute break out, you have a price and a process to redeem a partner’s interest. I’m giving a simplified version of what I recommend, but you get the idea. Most buy-sell agreements are vague where specifics matter most: Price and terms.
Yes, you need to deal with death, disability, and non-performance as well. I’ll save that for another post. Partnership dispute is the most likely problem to arise.
If you are just getting started, you probably haven’t got a good document if a partner decides to leave the business. Why? Most boilerplate agreements do not handle this issue with the specificity needed to bring swift resolution should a problem break out.
If the documents are inadequate, resolution comes through legal channels, and that’s very expensive.
Chris Reich, TeachU
