"I own a boat" says someone you are thinking of going into business with. In the next sentence you hear "I also have several investment properties".  Hearing this are you impressed? Well our clients were. A succession of them in recent years have entered into business relationships with people who used these exact lines.

The topic of this post is contemporary best practice for business structuring or collaboration formation, particularly to  develop and secure protection of intellectual property (IP). It's about how not to fall for lines about boats and property. The lines are designed to reel in people into one-sided ventures, often requiring upfront payments and work in return for vague promises of financial return.

The tone of this post is intentionally stern. I feel passionate about creating business structures that can be long-lasting for clients. I feel disappointment when businesses fail due to structuring issues.

I've written two practical Library articles on structuring. They are listed in the further reading list at the end of this post. But because Library pieces are intentionally sober, subtle and longer their key points do not always register with some readers. I want to inspire readers to read those articles before they decide to form a business structure or collaboration. The articles record lessons learned from a number of cases in recent years.

1.  What's the contemporary business structuring problem?

Inappropriate organisational or business structures, especially for entrepreneurial collaborations, are common in Australian. Why?

Our view formed from case work in recent years is that educational institutions, the myopic training of  some lawyers and accountants within their silos (knowing more and more about less and less), and the regulatory regimes and professional indemnity insurance arrangements shaping them, are conspiring to produce professionals lacking the necessary mix of expertise the marketplace demands and needs. This is especially so when the entrepreneurial collaboration is a small or medium-sized enterprise (SMEs).

The marketplace, including for the development and secure protection of IP, gives advantage to structures customised to achieve a mix of strategic, taxation, business and legal goals.

That's the REAL WORLD challenge that must be met as contrasted to the definition of a good outcome within the professional silos.

2.  How do the structuring problems arise? 

There's a common pattern at work. People in business and entrepreneurs gather and decide to work together. At some stage they see the need for legal and accounting advice to formalise their legal and financial relationship.

After an hour or less of consideration by their professional adviser they instruct their adviser to form a structure.

Remarkably at this stage the strategic and business goals of the venture are typically still unclear and rarely recorded in a cogent business plan or other sensible planning document.

Nonetheless a shareholders agreement, partnership agreement, trust deed, licence or other foundational and constitution-like and legally binding document is brought into existence by signature of it. On signature the boat and property bragger has now reeled in another one.

Pause and consider what's just taken place.

Where there's a race to adopt a structure, there's a lack of focus on the breadth and depth of future needs and challenges.

Sometime after things start up for the venture a real world problem arises. It may be a cash flow problem, a difference of view between the parties as to the direction to take, or a marketplace challenge that is exceptionally difficult to overcome.

If these issues fester and lead to a heated exchange of views they will make it LESS likely there will be an opportunity to resolve the issues and change unrealistic expectations within the enterprise. This is largely because the hastely prepared foundational documents lock in expectations, terms and conditions and lack customisation. They rarely contain clues for dealing with tough organisation-specific issues. With no reference to plans there is even disagreement as to what the issues are!

The under-worked nature of the foundational documents at this stage begins to become apparent. It is in this context a truly abstract document. Its existence can even be more of a hindrance than a help for charting a new course and preserving the value of what has been jointly created.

The downward spiral if not checked results in the commencement of the blame game. This is soon followed by either civil war (ie legal dispute or litigation between the parties) or dissolution of the enterprise.

Within months, potentially with insolvency professionals and litigation lawyers involved, the IP baby and other valuable assets can all too often be thrown out along with the structuring bathwater.

While the venture is now officially dead, its carcass can continue to cause issues for its founders. There may be tax office queries, creditors to pay and other problems. But let's move beyond and ask a deeper question.

3.  Why do business structuring problem arises?

Real world problems can be messy. They rarely arrive neatly boxed like Lego, all ready for assembly. Anyway in a rapidly changing business environment real world problems require thinking OUTSIDE the box. 

In recent years in the succession of cases I've referred to we have witnessed the experience of clients in disputes in small and medium-sized enterprises, charitable organisations, trading trusts and pretend licences or franchises. (The latter are licences or franchises in the eyes of the law, but they do not reflect commercially fair, sensible or sustainable deals between the parties.)

In these cases our clients were new clients who had the company, trust or franchise structures formed before they came to us. Otherwise they were existing clients whose business structures were formed by other lawyers or by accountants.

These cases involved a variety of arrangements. Some were between two or more private companies, a trust and a company, two sets of married couples, or between individual people in business.

The cases came to us when they had already became hot disputes. It was sometimes already too difficult to suggest use of a non-lawyer facilitator to try to work through to a solution. Nonetheless we reached an outcome in some cases by involving a lawyer acting as a mediator. This at least avoided court action.

When the cases reached us the anticipation of the parties was generally that their foundational document (eg shareholders agreement) surely contained the answers to unraveling matters. The parties were consistently wrong on this.

The common fault pattern emerging in the recent cases has been that each involved light treatment of issues in pre-structuring negotiations. Typically, the drafting of the foundational document did not resolve shortfalls as regards planning, process, information management and basic communication between parties whose personalities or styles were not perfectly compatible to begin with.

The parties and their accountants, solicitors or other professional advisers (if any) had not paused sufficiently to work out - who, why, where, when and what if questions - to better understand how the ventures would get from A to B including when challenges arose. They had not engaged with consultants, mentors or friends who know about strategic planning, asset or opportunity evaluation, cash flow forecasting and doing feasibility studies.

In each case, we worked with our client aiming for the best possible result in the circumstances. To be frank,  while some clients were very happy with the outcomes, personally I felt the ultimate results were patchy. Why? Here I turn to Abraham Lincoln.

For me structures on the way towards legal disputes or litigation immediately recall Lincoln's famous speech saying "A house divided against itself cannot stand". Lincoln's speech was before the American Civil War (1861–1865). The war caused a shocking level of loss and damage to human life and property. It was in a sense the first (brutal) modern war. The consequences and national grief were felt for decades by the North and South, if not over a century and to the present day. Iraq today confirms what current analysts and historians have noted for a long time about civil wars - they are a nasty business, among the worst types of war, few participants survive them unchanged. So if you are rushing into a business collaboration devote a minute of silence to ponder the American Civil War and Iraq today.

4.  Why is business structuring a priority need to solve? 

The priority for structuring decisions arises due to:

• COLLABORATIONS increased competition in markets, requiring more often than before the invention, development, marketing or distribution of products and services in collaborations rather than in sole operator structures;
• CHANGE  our era in which there are constant  waves of legal change requiring professionals who can design structures that can "see" further ahead, and
• FLEXIBILITY globalising markets in which Australian enterprises need structures that can adapt or scale up or down as needed.
  

Contributing to the heightened need to use appropriate structures is the increased complexity of business law.

5.  Closing mantra

When forming a business structure or collaboration until you work out how to get from A to B do not build or buy a foundational contract or structure eg a shareholders, trust, franchise, licence, deed or agreement.

Do not create a structure when you don't know the precise function it will serve. Memorise this mantra - if the venture plan is not in writing then it is just plain silly to sign a contract binding all to implement it. Read the articles listed below to help plan your next venture.

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Further reading: Preparing a business for sale or collaboration [PDF] and  Snakes and ladders for beginner entrepreneurs [PDF]