How Many Owners Should Your Business Have?

Human-owned is my term for businesses that are otherwise labeled closely-held or private. My conceit is intended to emphasize the intimacy in the relationship between owner, business and advisors to the business. Even though its stock is not traded on a public exchange, I wouldn’t call Facebook a human-owned business, and I’m not sure it is even a private business, a doubt shared, apparently, by the Securities and Exchange Commission (SEC).

This week The New York Times and The Wall Street Journal are reporting on investigations by the SEC of Facebook and other fast growing companies for whom an initial public offering (IPO) of stock seems likely. At issue is a federal law that requires otherwise private companies to disclose publicly certain financial information (as public companies do) when they have at least $10,000,000 in assets and 500 or more shareholders.
These companies have good reason to cap their shareholders at 499. While your company is unlikely to approach 500 owners, the situation begs the question: how many owners should your business have?

My answer: not one more than you absolutely need and have a signed shareholder agreement with.

Other than this SEC issue and the 100-shareholder limit on S corporations, the law isn’t that concerned by the number of owners in your business. Some states (not mine, Colorado) have special corporate statutes designed to work only with businesses owned by a limited group of folks, but those are supposed to help smaller companies, not be traps for the unwary.

There are, of course, plenty of legal gotchas that hinge on the number of people you employ. Other SEC rules governing how stock is offered kick in from the beginning of your business, without any connection to the 500 owner threshold. So, as laws go, the number of owners in a business doesn’t seem a big deal.

My real point (about time, eh?), however, is a practical one, and it is a big deal. Stock in a human-owned business should be owned only by those who bring substantial value to the business, and the terms under which that stock is owned should be thought-out and carefully documented.

The “substantial value” part of that equation is not just about money, though investors and details about their investments are critical. Stock-based incentives for key employees can be very effective tools for growing a business; just be sure the employees really are key before you start diluting your own interest by giving equity to folks who generally would be happier with a cash bonus.

The “terms under which stock is owned” bit is easier illustrated with a few of the questions I typically pose to my clients. For example, will you be happy with absentee owners, or do the owners of your company have to be active contributors to the workings of the business? If the majority owners want to sell the business, what are the rights of the minority owners? Can they buy the majority owners’ interests? Do they have to sell their stakes, too? Conversely, can the minority owners be excluded from the sale? Numerous ownership terms are possible—discuss them with your business lawyer, and put your decisions in place via a written shareholder agreement or buy-sell agreement.

Disputes over ownership of a business are some of the ugliest and most expensive around. Facebook, the early years as told in the film The Social Network, is a case in point, as is the tragic story of a Utah murder/suicide that followed a lengthy business ownership battle, as told this week by The Salt Lake Tribune.

I’ve not seen those extremes in my own practice, but I have seen ownership issues add complexity, delay, cost and emotional turmoil to a number of situations. Almost always, the troubles started with decisions to add owners that weren’t carefully made and thoroughly documented.

Do yourself and your business a favor, however many owners your business has or will have—talk to your legal advisors before offering stock to anyone, and be diligent in documenting the ultimate decisions, including any terms on ownership, in a written shareholder or buy-sell agreement.