Is Your Business Ownership Interest Documented? It Better Be.
Forming a business entity has become incredibly easy nowadays. At the Minnesota Secretary of State's Office, all it takes is 5 minutes filling out a one-page form and a filing fee. The form is called Articles of Organization for an LLC or Articles of Incorporation for a corporation. The person who signs the form is referred to as the “Organizer” for purposes of forming the company. One thing people sometimes do not realize is that legally speaking, Organizer is merely a title for the person that formed the company and is not the same as the owner.
After filing the Articles and starting the business, in their excitement over the venture, entrepreneurs often forget the most important aspects of forming a business, namely, designating who are the owners and their respective interests. The way we establish ownership interest in LLCs or corporations is through written actions or resolutions of the company. Such written actions or resolutions are typically drafted by a lawyer at the outset of the business designating the initial members or shareholders, identifying their respective proportion of ownership, stating their positions as officers, directors, or governors and often even authorizing the issuance of ownership certificates.
Creating such written actions or resolutions may not be very important to an entrepreneur who is the sole owner of their business, but in my experience and observation, it is critically important for businesses owned by more than one person. To be clear, unless and until your ownership interest in a business you co-own with another person is documented, it will always be uncertain.
I have seen many occasions where the failure to document ownership ended in disastrous results. For example, in one recent scenario, an entrepreneur whose interest in a business was undocumented, discussed sharing the business with his then girlfriend. Neither his sole ownership nor her shared ownership of the business was ever formally documented. He claimed that they merely discussed shared ownership but that he decided against it. Years later after their relationship ended, she successfully sued him seeking a buyout of her claimed 50% of the business.
Another dangerous scenario I have seen is where one owner does not want to have his or her interest in the business documented for one reason for another (such as to avoid creditors or the reach of an ex-spouse) so they decide to put the business in the name of just one of them. Without passing judgment on the legality or morality of such conduct, this scenario too can have disastrous results.
A recent Minnesota Court of Appeals drives this point home well. In Anderson v. Trails End Enterprises of Duluth, LLC, et al. (Unpublished Minn. Ct. App. Dec. A16-0256; Oct. 31, 2016), Mr. Anderson formed an LLC as a holding company for real property he had purchased and apparently intended that the LLC be co-owned with his business partner. They both however, decided it would be a good idea in the circumstances for the partner's girlfriend to be designated as sole member of the LLC. Years later Mr. Anderson sued the LLC, his partner, and his partner's girlfriend for hundreds of thousands in profits they had failed to share. Following a trial, the Court ruled that since Mr. Anderson's ownership interest was not documented, he had no claim to the profits even though it was “unusual” that he had donated the property to an LLC owned by his friend's girlfriend.
The lesson here is to make sure you document your ownership interest in a business.