Starting a Design Firm: When Two's a Crowd

Many of my clients and potential clients are in the process of setting up their own design firms. In my discussions with these design professionals, I am always interested to hear what financial and business management issues they have already considered or believe to be important. Often clients are focused on a single issue like cash flow or business development but have not thought about the wide range of issues, big and small, that can cripple a business once it is underway.

While I encourage founders of new businesses to have some form of owners’ agreement in place, even these comprehensive documents may not cause the founders to consider exactly how their business is going to run. The list below presents certain issues that owners of new businesses should agree on long before they buy that firm name plaque for the door.

Management

Every business confronts extraordinary management issues and day-to-day operational issues. Extraordinary issues would include borrowing funds, or taking on an additional business owner. How will the founders decide on extraordinary issues? Is there a majority owner who can make decisions alone? Will such decisions require unanimity? If it is one vote per person and there is an even number of owners, what will happen in the event of a deadlock? Day-to-day management issues, particularly for small start-ups with few people, can be even more crippling to the fundamental business of the firm which, at the outset, should be selling the work and doing the work. I have never understood (and confronted innumerable times) why all of the new business owners must be present in the conference room to go through stationery samples, figure out the IT network configuration and hire the bookkeeper. Each major business management area – finance, marketing, IT, employee management, facilities – should be delegated to one specific person who will check in with the other founders as needed.

Contributions

Although most businesses require a cash infusion to get off the ground, equity can be distributed for contributions of property or services in addition to money. Be clear about what each person is contributing to the business and how much of an equity interest they are going to receive for that contribution. If any of the owners are also loaning money to the business, repayment terms should be spelled out clearly and respected, just like a bank loan would be.

Distributions

This can be a particularly tough area because cash flow can be unpredictable and owners often have different personal needs. I have seen many different approaches by new businesses in deciding how money will come out of the business including agreements to reinvest all revenues in the business for a certain period of time; distributing only net income to the owners, whatever that net income may be and whenever the owners agree it is prudent to distribute it; or having the owners receive a salary-like draw from the day one of the new business.

Another issue to consider in this area is that many new business co-founders are friends but have not worked together before. What if one person is not pulling his or her weight? Is there some kind of objective measurement (best defined before the business begins) that will enable an adjustment of the distribution amounts?

Non-Compete/Corporate Opportunities

Moonlighting seems to be a familiar word to many design professionals. The enthusiasm that surrounds a new business, like a new marriage, should not get in the way of planning for contingencies, like infidelity or divorce (see below). Be clear about whether all “related” opportunities must come to the new business, and what related means. Also, if a particular owner does not succeed in the business, will there be restrictions on what business activities the owner can pursue after his/her departure.

Departures/Terminations

New business ventures should be called new business adventures. Some people are just not going to adapt to the ride. Consider in advance what will happen should someone decide to leave the firm. Will they be paid for their ownership interest? Based on what? What is someone gets ill or dies? Set out criteria that would permit termination of an ownership interest if it is just not working out. Will an ownership interest be paid out differently depending on whether it is a termination, a voluntary or an involuntary departure? It is important for design professionals in particular to be mindful that ownership interests in design professional firms are highly restricted so make sure shares of departing owners are returned to the firm, acquired by existing owners or that new owners are subject to firm/exiting owner approval.

As most design professionals know, a strong building starts with a strong foundation. Your business shouldn’t be thought of any differently.