Starting a Business With a Friend or Family Member in Illinois? Put These Agreements in Writing First may not sound like the most exciting advice when two people are enthusiastic about launching a new company. But some of the hardest business disputes begin with people who trusted each other enough to believe they did not need formal agreements.
Friends, siblings, spouses, parents and adult children frequently start businesses together because they already have a relationship. That trust can be an advantage, but it should not replace clear documentation.
This article focuses primarily on limited liability companies (LLCs), which are a common choice for small businesses in Illinois. Other entity types, such as corporations and partnerships, may be governed by different rules.
Before investing money, signing a lease, hiring employees, or dividing up responsibilities, Illinois business owners should decide how the company will actually work when everyone does not agree.
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Put Ownership Percentages in Writing
One of the first questions should be simple: Who owns what?
Do not assume that ownership will be obvious because one person contributed more money while another contributed more labor.
The documents should state each owner’s percentage interest and identify what each person is contributing to the company. Contributions might include cash, equipment, intellectual property, property, existing customers, or other assets.
For an Illinois LLC, the operating agreement can regulate the company’s affairs and the relationships among its members, managers, and the company. When an operating agreement does not address an issue, the Illinois Limited Liability Company Act (805 ILCS 180) supplies default rules instead.
That makes it important to decide the rules intentionally rather than discovering the statutory default after a disagreement has already developed.
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Create a Detailed Operating Agreement
Simply filing paperwork with the Illinois Secretary of State is not the same thing as creating a complete agreement between the owners.
An Illinois LLC is organized by filing Articles of Organization with the Secretary of State. The operating agreement, however, is where owners can address many of the rules governing their relationship.
A well-drafted operating agreement may address:
- Ownership percentages
- Voting rights
- Management authority
- Capital contributions
- Profit distributions
- Member compensation
- Admission of new owners
- Transfers of ownership interests
- Buyouts
- Death or disability
- Dispute resolution
- Dissolution of the company
This becomes especially important when family relationships and business relationships overlap.
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Decide Who Actually Has Authority to Make Decisions
Many people start a company saying, “We’ll make the decisions together.”
That sounds reasonable until they disagree.
By default, an Illinois LLC is treated as member-managed unless the operating agreement designates it as manager-managed. In a member-managed LLC, each member generally has equal rights in managing the company, and many ordinary business matters may be decided by a majority of the members. Certain significant actions require all members’ consent.
That can create obvious problems in a two-person company.
If two friends each own 50% and disagree on a major decision, who breaks the tie?
The agreement should address decision-making authority before a deadlock occurs. It may identify which owner controls specific areas of the business, require approval for transactions above a certain dollar amount, or establish a process for resolving deadlocks.
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Agree on Money Before Money Becomes the Problem
Many business disputes eventually come down to money.
Owners should discuss how much each person must contribute initially, whether additional contributions may be required, and what happens if the company needs more capital, but one owner cannot or does not want to contribute.
They should also distinguish between ownership, salary, and profit distributions.
Someone who owns 50% of a company does not necessarily have to receive the same salary as another 50% owner who works substantially different hours or performs a different role. Those expectations should be addressed clearly and coordinated with the company’s tax and accounting professionals.
Written agreements should also establish rules for business expenses, reimbursements, loans from owners to the company, and access to financial information.
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Define Everyone’s Job
“Alex handles sales and Jamie handles everything else” may work when a company has two clients.
It becomes much less workable as the business grows.
Owners should clearly identify their respective responsibilities. Who handles employees? Who manages finances? Who can sign contracts? Who talks to vendors? Who has authority over marketing? Who can borrow money on behalf of the company?
The more specific the agreement is, the less likely the owners are to later argue about who was supposed to do what.
This can be particularly important in family businesses, where expectations about work sometimes arise from family roles rather than actual business responsibilities.
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Have a Buy-Sell or Exit Plan
Every business relationship eventually changes.
An owner may retire, move away, become disabled, get divorced, die, lose interest in the business, or simply decide that the partnership no longer works.
The question should not be whether someone might eventually leave. The question is what happens when they do.
A buy-sell arrangement can address:
- Events that trigger a potential buyout
- Who has the right or obligation to purchase an interest
- How the business or ownership interest will be valued
- How the purchase price will be paid
- Whether installments are permitted
- What happens upon death or disability
- Whether an owner may sell to an outsider
Illinois law distinguishes between transferring an economic or “distributional” interest and giving someone full membership and management rights in an LLC. A person receiving only a transferred distributional interest does not automatically become a member or gain management rights.
A carefully drafted operating agreement can therefore be especially important when owners want to control who may eventually participate in the business.
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Decide What Happens if the Owners Have a Falling Out
Business owners rarely expect litigation when they start a company together.
Planning for disagreement does not mean expecting the relationship to fail. It means recognizing that reasonable people sometimes disagree.
The agreement can establish a process such as negotiation, mediation, arbitration, or litigation for resolving disputes. It can also address what happens if the owners reach a permanent deadlock.
Having a predetermined process may prevent a business disagreement from immediately turning into expensive litigation—or destroying an otherwise viable company.
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Protect the Company’s Confidential Information
Depending on the business, owners may have access to customer lists, pricing strategies, vendor information, trade secrets, marketing plans, passwords, proprietary methods, and other confidential information.
Business owners should consider appropriate confidentiality, intellectual-property, and related agreements based on the nature of the company and current Illinois and federal law.
The important point is to establish who owns the company’s intellectual property and what happens to confidential business information if one owner leaves.
Frequently Asked Questions About Starting a Business With Someone in Illinois
Do two friends forming an Illinois LLC really need an operating agreement?
It is strongly worth considering. Illinois law allows members to use an operating agreement to establish many of the rules governing the company and their relationship. Without customized terms, the default rules in the Illinois Limited Liability Company Act may apply.
Is a 50/50 business partnership a bad idea?
Not necessarily, but it creates a particular risk: deadlock. Two equal owners should establish in advance how disagreements will be resolved when neither side has majority control.
Can my business partner sell their share to anyone they want?
Not necessarily. Illinois LLC law distinguishes between transferring a distributional interest and transferring full membership rights, and an operating agreement can play an important role in governing transfers.
Should family members still put everything in writing?
Yes. In fact, clear agreements can help preserve family relationships by reducing misunderstandings about money, authority, ownership, and expectations.
Build the Business Relationship Before Problems Begin
Starting a company with someone you trust can be a tremendous opportunity. But trust and good legal planning should work together.
Rincker Law, PLLC assists Illinois entrepreneurs, family businesses, farms, and other business owners with LLC formation, operating agreements, ownership arrangements, buy-sell planning, contracts, and business disputes.
If you are starting a business with a friend or family member or already own a business together and realize your agreements need attention, contact Rincker Law, PLLC at (217) 774-1373 to discuss your business structure and legal documents.
Legal Disclaimer: This article is for general informational purposes only and does not constitute legal or tax advice. Business laws and individual circumstances vary. Reading this article does not create an attorney-client relationship.