Before Saying “I Do,” Get A Partnership Agreement

For those who dream of starting a successful business and leaving their day job, one critical decision is whether to take on a business partner.  Oftentimes, the rationale for bringing on a partner is that he may have strengths in areas where you are not as skilled.  For example, you may excel with business development but lack the technical expertise that you believe will be critical to the success of the new business.  The decision to take on a business partner is frequently not given enough thought, even though it can have a serious impact on whether the business ultimately succeeds.

A partnership agreement that memorializes the consensus reached between the partners on key issues is critical for both the partnership and the business to succeed.  Below are five topics that should be thoroughly discussed among the partnership and, once a consensus is reached, memorialized in the partnership agreement.  Although this article refers to a partnership agreement, this term is also inclusive of operating agreements, bylaws, articles of organization and other founding documents.

Death or Departure of Partner

The death or departure of a partner must be discussed and provided for in the partnership agreement.  If an agreed upon course of action is specified in the partnership agreement for the death or departure of a partner, the likelihood of a partnership dispute is minimized.  For instance, if a partner dies, the partnership agreement needs to specify whether the partner’s spouse or surviving children can assume her interest in the partnership or whether the remaining partners have the right to purchase the deceased partner’s interest.  Because business partners often join forces to fill a skill set that the other partner is lacking, the remaining partner often does not want to have the deceased partner’s family member assume the role of partner because that family member likely does not have the same skill set as that of the deceased partner.  A buy/sell agreement, which specifies how the deceased partner’s interest will be valued and paid out to his next of kin, as well as the partnership agreement, can resolve these critical issues.  Of course, both the buy/sell agreement and the partnership agreement should be in place at the very beginning of the partnership.

Likewise, the departure of a partner must also be discussed and addressed in the partnership agreement.  For instance, can the other partners vote out another partner?  If so, on what grounds? How will the interest of the departing partner, whether it be the result of a voluntary or involuntary departure, be valued and paid out?

While no one likes to discuss breaking up the partnership before it even begins, it will save you a lot of money and headaches to discuss and memorialize the consensus on these issues at the beginning of the partnership, while everyone is on good terms.

Capital Contributions

Every partnership agreement should detail how much capital each partner contributed to the business, as well as outline how additional capital will be raised by the business.  For example, if five (5) partners contributed $30,000 to start the business, then where will additional capital come from?  Indeed, your partners may not have sufficient personal liquidity to respond to a capital call.  If additional capital is needed, the partnership agreement should specify where additional capital will come from, as the failure of some of the partners to respond to a capital call could dilute their membership interest in the business and create conflict among the partners.

Decision-Making

The day-to-day management of the business, as well as the limitations on each partner, need to be clearly stated in the partnership agreement.  How decisions are made within the business can be a point of friction, especially if the decisions at issue are major decisions and can influence the direction of the business.  The friction among partners can be especially acute when there are only two (2) partners in the business and both have equal voting rights.  Absent a partnership agreement that clearly sets forth how to resolve a deadlock, the partnership could be on a course for disaster.  A structure to timely resolve an impasse must be memorialized in the partnership agreement so that a final decision can be made and deadlock can be avoided.

Ownership

A well drafted partnership agreement specifies the roles of each partner and the percentage of ownership interest held by each partner.  While the typical business ties the percentage of ownership interest to each partner’s capital contributions, this is not always the case.  Some businesses have a partner who contributes all of the capital needed to get the business going, while the other partners contribute sweat equity.  Regardless of the particular arrangement that your business has, there should be a written partnership agreement that leaves no doubt about the percentage of ownership interest each partner has in the business.

A partnership agreement also can provide a mechanism by which the partnership can respond to the scenario where one partner abruptly stops making contributions to the business.  The mechanism that can allow the partnership to respond to such a scenario is a vesting ownership scheme.  We have all heard the stories of one partner losing interest in the business, while the other partner is working every waking hour to grow the business.  By having a vesting ownership scheme in the partnership agreement, you can create a framework by which each partner has to meet certain metrics for their ownership interest in the business to vest.  If the partner fails to meet those specific metrics, then the business is able to purchase that partner’s membership interest for a nominal amount.  Without a vesting scheme, the partner who stopped contributing will be entitled to their share of the company’s profits.  As you can imagine, if the business is profitable, the derelict partner is not likely to give up his ownership interest.  Although putting in place a vesting scheme in the partnership agreement can be somewhat complicated, it can be very helpful to ensuring the success of the partnership and minimizing the chances of a contentious partnership dispute.

Money

The cause of many problems in a partnership, just like a marriage, revolve around money.  We recommend that every partner have an open and extensive discussion about their personal finances, as well as the expectations they have for the financial growth of the business.  For example, every partner needs to understand and agree on how long they will wait to take money out of the business, whether they will be repaid for their capital contribution and whether profits will be reinvested in the business or distributed to the partners.  Every partner must be in agreement on these key issues from the very beginning of the partnership.

A comprehensive partnership agreement creates a roadmap for the business partners to rely on as they face the challenges that come with starting and growing a business.  By having this framework in place early on, you increase the chances of maintaining the partnership and creating a successful business.  Even if you have already entered into a partnership, it is not too late to get a written partnership agreement in place.  Although bringing up the subject may be somewhat uncomfortable at first, you may be glad that you did.

Disclaimer:  This article is for educational purposes only and to give you general information and a general understanding of the law, not to provide specific legal advice.  The article content should not be used as a substitute for competent legal advice from a licensed professional attorney in your state.

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Written by Law Firm of J.W. Stafford, L.L.C.

Attorney Jamaal (“Jay”) W. Stafford has extensive experience counseling and representing clients facing complex and challenging legal issues. He puts his experience to work with each client to help them get their desired results, no matter what legal situation they are facing. Each service that is offered is backed by his experience, education, professional training, and passion for employment law and litigation.