Partnership Agreements 101
So you’re a new entrepreneur and are considering creating a partnership with a close friend, what could possibly go wrong? The truth: EVERYTHING. Sadly, we constantly come across business partners that are no longer able to work together and want a fast exit. The only time the exit is truly clean is when they have a partnership agreement that anticipated this situation and contained an exit strategy. Otherwise, ending business partnerships can become just as messy and emotional as ending a marriage. Therefore, I always recommend consulting with an experienced and competent business attorney when you consider ending your business partnership. Every case and situation is different and truly requires the eye of an experienced attorney to guide you through the difficult time.
However, this article is dedicated to explaining what can be done BEFORE the partnership is created so to avoid the headache and difficulties that so often result when working with another.
Are They a Good Fit?
First and foremost, make sure that you can actually work with the individual you decide to partner with. This may seem obvious, but is often misinterpreted by many new entrepreneurs. Which is exactly why people often assume that their best friend or spouse would be the ideal business partner since they already get along so well. However, a business relationship is distinct than other relationships; because, unlike your other relationships, the injection of emotion is usually harmful to a business. Therefore, different criteria must be used in determining who to be your business partner.
Unfortunately, there is no magical answer; different strategies work for different partners. Regardless, there does seem to be a general pattern that I have seen in successful partnerships. Typically the two individuals bring different talents or skills to the business, that when combined result in a more well-rounded business. As odd as it may sound, your business is essentially you and your partner’s child and you obviously want your child to have the best characteristics from both parents. For instance, if you are very detail oriented and a perfectionist, it is often wise to partner with an individual that is more focused on the big-picture. On the other hand, you may have the vision and talent but not the money to start your business. In this case, a good partner may be someone that is willing to invest the capital necessary for you to accomplish these dreams. Like I said, there is no winning formula, but attempting to find a partner that can contribute to the business in a way that you cannot is typically the best strategy.
Partnership Agreement:So you’ve found that perfect business partner, now what? The partnership agreement is what. This is the single most important document for your business, because it will contain the exact responsibilities of you and your partner, should anticipate numerous problems that may occur, and provide practical solutions. Not every partnership agreement is created equally and an attorney should always be consulted when forming the partnership so to ensure that future problems can be skilfully avoided. However, there are things that every partnership agreement should contain. Specifically, provisions for three important areas: the roles and responsibilities of each partner, the compensation structure, and exit clauses.
Roles and Responsibilities of Each Partner: Typically partners have equal ownership interests in the business, with each contributing 50% of the initial investment. However, as illustrated above, one partner may contribute a greater investment when the other partner brings the required skills. Therefore, this section should include what initial investment each partner shall be making and what role each partner will play in the actual operation of the business. For instance, who is in charge of management of possible employees? Who is in charge of bookkeeping? Who is in charge of marketing? The more thorough and detailed this section is, the easier it will be the avoid problems and confusion in the future (think 1 year from now, 5 years from now, 10 years from now).
Compensation Structure: This is, again, a section of the agreement that will vary largely between different partnerships. By default, partnerships typically divide all revenue 50/50; however, this can always be customized to the specific needs of the partnership. However, the most important provisions in the compensation section is when and how compensation is to be disbursed. Many partners believe it is smart to not initially collect compensation so to allow the business to grow and then begin disbursing revenue when a target revenue amount is reached. I personally recommend this format for business partnerships as well. Therefore, realistically consider your business’s projected revenue and build various scenarios where compensation would be allowed—for amount and time. For instance, the agreement can stipulate disbursement of profits after the net profits of the company reaches $100,000 in the first year or $25,000 in the first quarter. The exact details are limitless and should be explicitly agreed upon by both partners.
Exit Clauses:Most importantly, the agreement should anticipate possible situations that would require both, or either of the parties to exit the business. These could include the policy if one partner decides to quit the business, does the other partner then have the first opportunity to buy his shares? This is typically known as the right of first refusal. What if you want to add a new partner? Specific strategies for adding a partner should be included; such as, how to select a new partner, and if they are then required to contribute a capital investment. What if both partners decide to end the business? The agreement should then include terms on how to liquidate and divide all the assets. Deciding the procedure for assessing the value of the business will also help streamline possible issues when attempting to dissolve or sell parts of the business. Regardless, numerous possible scenarios should be included to help avoid possible arguments that may arise later.
Conclusion: Starting a business is an important chapter in any individual’s life and all aspects should be given serious thought and consideration. Specifically, the foundation of the business will truly determine it’s future success. This is especially true if you are deciding to start a business with one or more partners. As such, I always recommend that you ensure your business’s success with a partnership agreement that can survive all possible problems that you may face in the future.
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Eamon Jafari, Esq. is a founding attorney at Barrington Legal, a full-service law practice that prides itself on helping small business owners and entrepreneurs.