Protecting your interests in a group investment (Part 3)

Note: This post is part of a series of posts on the fundamentals of partnership agreements and investing as part of a group. See the introduction to the series here.

Figuring out the management

Since the point of your partnership agreement is to protect you against inappropriate acts by your partners (such as taking all the money and running off to Aruba), we have to take some time to expressly define how the company is going to be run. You need to define your leadership, set boundaries on your management and make sure that any situation not covered in your plan is brought to the attention of the ownership.

Did you get all of that? If not, don't worry, we'll walk through each of them.

The difference between leadership and management is that leaders figure out the path and goals for the company, while the managers make sure that path is followed and that the goals are reached.

Your leadership is obviously going to consist of your owners, because they make the final decisions. Your managers can also be owners, or you could use a third party (such as an employee or, in real estate, a property management company).

So we defined who our leaders were when we figured out what the ownership interest were. The next step is to determine how decisions amongst the leadership will be made. Most often this is by a majority vote, but that leaves a lot of questions unanswered. Specifically you need to answer the following questions:

• Who can vote?
• How many votes does each owner get?
• Does every owner need to be included in every decision? (For example, if there are 4 owners with 25% each, and three of them decide they want to buy something, does the fourth have to be asked since the majority was already achieved?)
• Who can call a vote?
• How do you bring an issue to a vote?
• What happens if one (or more) of the owners is unavailable at the time of the vote?
• Can an owner designate a representative to cast his votes during times of absence?

That's a lot of questions to deal with, but it sets a very strong foundation for the future operation of the company. Even issues such as a simple majority vote can be negotiated. In our Subway franchise example, I own 55% of the company while Uncle Joe owns 45%. But to preserve the partnership we can reach an agreement that for a vote to pass it must receive at least 60% of the vote. That way, for now, I can't force any decisions on Uncle Joe. But if we accept other investors in the future, I'll still be in a very strong position.

Once we've defined the leadership we have to set boundaries on the management. Whether the business is being managed by an owner or by a third party, strong rules need to exist to allow the manger to deal with simple daily problems, while raising major issues to the leadership.

A simple way to achieve this is to define Ordinary Business Activities. In the Agreement between Biff and I, I defined Ordinary Business Activities as:

"the normal day-to-day business activities of the Partnership and excludes activities involving decisions that could potentially have a substantial current or future impact on the Partnership's assets, debts, income or expenses".

This list should mostly cover everything you think should be accomplished without needing a vote. Looking at our fictional Subway franchise a list of Ordinary Business Activities could include:

• Opening and closing the store
• Making and selling sandwiches and other foodstuffs (restricted to the menu)
  
• Ordering supplies (within certain limits)
• Accepting job applications
• Building maintenance
  

Actions that aren't included within Ordinary Business Activities, and thus would require a vote to execute could include:

• Hiring or firing employees
• Giving raises
• Purchasing equipment
• Menu changes
  

In addition you probably want to define certain exceptions to the OBA rules, where certain events always require a vote, such as entering a contract with an annual cost of over $1,000 (say, with a cleaning and maintenance company).

The last thing you need is to have a manager be hamstrung by overly restrictive rules that make him require a vote on every possible activity. But at the same time you don't want the manager to be making unilateral decisions that significantly impact the future of the company. In other words, you don't want the manager to be allowed to do whatever he likes.

These rules and boundaries are extremely important to record and update whether you are participating in management or not. If you are managing an aspect of the company, then this will give certain decisions to you and you alone. If other owners object to your choices, you can easily provide them with the evidence that the decision was yours to make. If you aren't involved in the management of the company, then this is a way of ensuring a level of accountability.

Introduction - The basics of entering a group investment
Part 1 - What a partnership agreement is, and what you need to know about it
Part 2 - What is my interest and how do I determine it?
Part 3 - Figuring out the managment