Truth 29. Starting a business as a team rather than an individual
One of the most significant decisions a prospective business owner makes is whether to launch a business as a sole proprietor or whether to take on one or more partners. There is no best choice that works in all situations. The choice normally boils down to whether the idea for the business was conceived with others and whether the people involved are equally committed to starting a business.
While most businesses are started as sole proprietorships, a growing number of businesses are started by a team of two or more people.[1] Businesses that fit this criterion must organize as a partnership, corporation, or limited liability company. It’s normally not a good idea to organize as a general partnership, because the individual partners are liable for all the partnership’s obligations. This complication can be overcome by organizing as a corporation or a limited liability company, as described in Truth 19, “Choosing a form of business ownership.” It’s best to have an attorney involved to help you navigate the legalese of starting a business with two or more people, to make sure you select a form of business ownership that meets your collective goals.
Most founding teams consist of two to four people. A team larger than four people is typically too big to be practical.[2]
Advantages to starting as a team rather than an individual
It’s generally believed that new businesses started by a team have an advantage over those started by an individual. A team brings more talent, resources, ideas, and professional contacts to a new business than does a sole proprietor.[3] In addition, the psychological support that cofounders of a new business can offer one another may be an important element in a firm’s success.
It’s generally believed that new businesses started by a team have an advantage over those started by an individual.
Several factors affect the value of a team that is starting a new business. First, teams that have worked together before have an advantage. If people have worked together before and have decided to partner to start a business together, it usually means that they get along personally and trust one another.[4] They also tend to communicate with one another more effectively than people who are new to one another.[5] Second, if the members of the team are diverse in terms of their abilities and experiences, they are likely to have different points of view about technology, hiring decisions, and other issues. Typically, these different points of view generate debate among the founders, reducing the likelihood that decisions will be made in haste or without the airing of alternative points of view.
Disadvantages to starting as a team rather than an individual
There are two potential disadvantages associated with starting a business as a team rather than as a sole business owner. First, the team members may not get along. This is why investors and others favor teams consisting of people who have worked together before. Second, if two or more people start a business as “equals,” conflicts can arise when the business needs to establish a formal structure and designate one person as the chief executive officer (CEO). If the business has investors, the investors will usually weigh in on who should be appointed CEO. In these instances, it’s easy for the founder who wasn’t chosen as the CEO to feel slighted. This problem is exacerbated if multiple founders are involved. At some point, a hierarchy will have to be developed, and the founders will have to decide who reports to whom.
Founders’ agreement
One of the smartest things a team of founders can do to avoid the pitfalls identified in the previous section is to draft a founders’ agreement before the business is started. A founders’ agreement is a document that deals with issues such as the relative split of the equity among the founders of the firm and how individual founders will be compensated for the cash or the “sweat equity” they put into the firm.[6] The items typically included in a well-developed founders’ agreement are as follows:
Nature of the prospective business
A brief business plan
Proposed titles of the individual founders
Apportionment of stock (or division of ownership)
Identification of any intellectual property signed over to the business by any of the founders
Buyback clause, which explains how a founder’s shares will be disposed of if he or she dies, wants to sell, or is forced to sell by court order
Having a founders’ agreement ensures that the founders have addressed and hashed out critical issues regarding their respective roles in the business before the business is started.