How to be safe when investing in a friend's business – Business Daily
QUESTION: Dear Cathy, My friend has been working on software known as ujanja which he has now completed. To sell the software he wishes to register a new business. He has requested me to partner with him as an investor, by investing Sh1 million in return for a 40 percent stake in the new business.
He also presented me with the cash projections and I am confident that this is a good investment. I am only worried about protecting my interest in the business. What legal advice would you give me as an investor?
Certain markers should inform whether a business would be a good investment or not. Before giving you the legal advice on what to look out for, I would advise you to also seek advice from financial experts who would be able to advise on the feasibility of the new venture.
In the meantime, these are the legal tips I can offer you. The first would be to ascertain what type of business you both intend to register. You have three options that are a partnership, a limited liability partnership, and a company. I would recommend a company for this type of venture.
At this stage, I advise a joint venture agreement which is an agreement between two or more persons who wish to undertake a joint business or venture together.
This type of agreement is a highly specialised agreement as it sets out with clarity the distinct roles and rights of each partner in the business. There are two main types of joint venture agreements.
The simpler one is where two or more persons agree to collaborate on a one-off venture, for example, an agreement to submit a joint tender during a procurement process. The more complex one is where like in your case, a new business is being formed.
The joint venture agreement contains a very accurate description of the joint business including the name, the location, the shareholding and capital structure. It also sets out each person’s contribution or role in the new venture.
For example, in your case, your friend would be contributing his technical expertise to the business, valued at 60 percent ownership while you would be making a financial input valued at 40 percent ownership.
A joint venture sets out governance aspects of the business such as decision making, voting, directorship, bank mandates, and others.
Improper decision-making and governance structures are the main reasons why partnerships fail. Setting these out from the onset will provide clarity and minimise the risk of disputes.
Speaking of disputes, a dispute resolution clause is also a very important part of joint venture agreements. I would advise alternative dispute resolution mechanisms such as mediation and arbitration as these are more efficient than going to court.
Have you considered at what point you would wish to exit the business? Are you in the business for the long-term or do you wish to exit once you recoup your investment and make a profit?
The joint venture agreement contains an exit clause that provides clarity on how and at what point to exit the business. As joint venture agreements are too detailed to highlight in this column, kindly seek professional advice from a lawyer.
Once you sign the joint venture agreement, then you can now incorporate the company. Remind your friend that all the property rights in Ujanja software now belong to the company. He will need to assign whatever rights he was holding including the name “ Ujanja” to the company through deeds of assignments.