The Truth About Partnerships
Business partnerships have often and very accurately been compared to marriages. The truth is that there are not many relationships in our lives that come close to the relationship we have with our business partners. Consequently, just as divorces can have an impact that goes well beyond the two people involved, disputes can affect all aspects of a company, including employees, suppliers, customers, and sometimes the whole industry. Partnership disputes are very often the cause of business failures. For this reason alone the partnership agreement is one of the most important documents for the health and security of your enterprise and should be signed as early in the partnership as possible. In this article, a partnership agreement is referred to generically, to include operating agreements (for LLC’s) and bylaws and shareholder’s agreements (for corporations).
Most states do not require written partnership agreements, and it is tempting to skip this step. However, when disputes arise, as they invariably do, and no written partnership agreement exists, parties may be forced to resolve those issues through lengthy—and often expensive—negotiations or litigation. If you don’t have a written partnership agreement, the state in which you have incorporated will provide you with one. The state’s statutes will govern the relationship among the owners, and the operation of the company. But relying on that backdrop may have unintended consequences. For example, in Georgia, profits and losses of a limited liability company are shared equally among its members regardless of how much capital each member contributed, unless the members agree otherwise in an operating agreement. So if you formed an LLC with a partner, and you contributed most of the capital, you would still be entitled to only 50% of the profits—unless you have a written agreement.
Here are some major issues that business owners overlook, or at least don’t want to discuss, and that should be addressed in the partnership agreement.
Buy–Sell Agreements: These provisions govern situations in which an owner dies, becomes disabled, or chooses to leave the business. It should address what events trigger the provisions, who can buy the departing owner’s interest, and at what price the interest may be purchased. The provisions serve to protect both the remaining, and departing, owners. Buy-sell agreements can be insured, and in the event of death, are funded by the life insurance proceeds of the owner.
The price may be fixed or determined by some method or formula, such as an appraisal. The price could be paid up-front in cash or in installments over time. Also, you can set different prices and terms for different events, one for retirement, one for disability, and another for voluntary or involuntary withdrawals.
Non-compete Provisions: These provisions are important to protect the value of the business that is being built. What if a departing partner opens a competing business across the street or in the same city? What if an existing partner invests in a competitor and uses the knowledge that you have built up in the new business? Including a non-compete provision can prevent these types of damaging situations.
Management: Who will be primarily responsible for making the day-to-day decisions of the company? How will major decisions, such as dissolving the company or selling all of the company’s assets, be made? Depending on the experience of the partners, you may decide to vest the company’s day-to-day operations in a manager or officer. The manager or officer may be an owner or an outside party. No matter how you choose to structure the management of the company, it is important to clearly state who may (and who may not) bind the company. It is also important to address the procedures for removing the managers or officers if they are not adequately performing their obligations.
If more than one owner will be managing the business together, then the agreement should address how deadlocks will be resolved. You can consider a buy-sell being triggered, binding mediation, or going through arbitration.
Conclusion: Don’t look at drafting a written partnership agreement as an expense; look at it as an investment.
Business Insights is hosted by the Law Firm of Kumar, Prabhu, Patel & Banerjee, LLC (KPPB).
Hunter Street is an attorney of counsel at KPPB, primarily working on commercial real estate and business law transactions.
Disclaimer: This article is for general information purposes only, and does not constitute legal, tax, or other professional advice.
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