Partnerships Agreements

When you decide to go into business with one or more other people, the first word that comes to mind is probably partnership. And it can be used to describe two key elements of your venture: the first is the legal structure of your company; the second is your relationship with the other owners. Both issues are critical and need to be addressed in detail early on—ideally before you are actually up and running, well before any conflicts arise.

The actual exercise of making the decision of a company legal structure and mapping out the operational details will lay a solid foundation for the business itself and the partners’ relationship. If you encounter problems with this process, you’ll probably have more serious problems later on. After all, if you can’t write a partnership agreement together, how are you going to run a business? But if you can draw up an agreement that is fair and supported by all parties, your chances for business success are greatly enhanced.

Partnership as a legal structure
A partnership is one of the basic options you have when determining the legal structure of your business. The others include a sole proprietorship, a limited liability company and a corporation.

Under the partnership structure, you can choose a general or limited partnership. In a general partnership, each owner is typically active in the business and shares in its liabilities, responsibilities, and rewards. A limited partnership is similar, but has two classes of partners: general partners, who have control over the business and accept full liability for it, and limited partners, who do not participate in the daily operations and whose liability is limited to their investment.

A good general partnership agreement will be complex, because it should cover all possible business situations the partners may encounter and outline procedures to resolve conflicts.

Some of the items your partnership agreement should cover include:

   • The purpose of the partnership. Articulate the reason the partnership is being formed
     and describe the scope of the business.
   • Capital contribution of partners. Who is putting in what in terms of cash and assets?
   • Profit and loss sharing of partners. How will profits and losses be distributed?
   • Voting rights of partners. Not all partnerships are necessarily equal. You may calculate
     voting rights based on the value of each person’s financial or management contribution.
   • Delegation of management authority to partners. Determine who has authority to do
     what on their own, and when other partners must be involved before a decision can be made.
   • Designation of a tax matters partner. Name one individual who is responsible for
     dealing with the Internal Revenue Service in the event of an audit.
   • Disposition of a partner’s interest upon the death of that person. If not otherwise stated
     in the partnership agreement, a general partnership will automatically dissolve on the
     death of a partner. Plan ahead for a smooth transition and to protect the business and
     survivors.
   • Methods to resolve tie votes between partners on crucial partnership decisions. How
     will you break a deadlock?
   • Admission of new partners. As your business grows and changes, you may want to
     expand the ownership of the company. Know in advance how this will be done.
   • Bank account signature authority. Who can sign and how many signatures will be
     required on bank accounts.
   • Exit options. If one of you wants out of the partnership for any reason, how will it be
     handled? The typical method is a buy-sell agreement, and the details should be
     established long before it ever becomes an issue.

Other options
Though you may want to be in business with one or more others, you don’t necessarily have to set the legal structure up as a partnership. Choose the legal structure that is best for your business. Depending on the type of company and the liabilities involved, it may be better to form a corporation or a limited liability company. The documents that govern the company may look different, but they should still cover all the important issues. Partners and shareholders who can’t agree all-too-often end up in court; you can avoid that by preparing for as many eventualities as possible up front.

You may choose to draw up your own partnership agreement or have an attorney handle it for you. Either way, have the final documents governing your business reviewed by a lawyer to make sure you have adequately addressed all the critical points. Choose a lawyer with experience in incorporating and drafting bylaws, shareholder agreements, and partnership agreements.

Partnership as an operating issue
Once you have determined the legal structure, you need to set up your operating structure. Many elements of the operation will be addressed in your partnership agreement or, if you incorporate, in your bylaws and shareholders’ agreement; others will be discussed in your business plan. The key is to be sure you have spelled out the arrangement in sufficient detail that all the partners understand and agree on the goals of the business and the methods to be used to reach those goals.

As part of planning for the future, consider your prospective partners’ history. How are their earlier business successes and failures likely to impact your venture? Do they have experience you can benefit from, or is there a pattern of repeating the same mistakes? In a marriage, you know your spouse might very well end up just like their parents. In business, if you know your partners’ history, it’s easier to project how they will operate with you.

Clear partnership agreements are especially important when the partners are friends or spouses. Don’t assume you feel the same way about anything; when you start working on the details, you may be surprised at where you agree and where you don’t. Clearly written documents will allow you to resolve any differences and arrive at a mutually-agreeable method of operation before any problems arise.

Regardless of how you set up the partnership, consider these tips for establishing a solid, long-term working relationship with a business co-owner:

   • Outline who is responsible for what in the day-to-day operation of the company. It’s a good idea to write job
     descriptions to assure that there are no misunderstandings.
   • Agree on a mission statement. This sentence is the foundation for your entire operation, and it’s critical that it
     be based on a vision all the partners share.
   • Write down your goals. Make sure you both want the same thing from and for your  business. If, for example,
     one partner wants to stay small and the other wants to grow, conflicts are inevitable.
   • The same potential applies if you are not working toward the same financial goals.
   • Determine your compatibility when it comes to management and operating style. It helps to have partners who
     agree with your own philosophy and approach. If one person is autocratic and the other is democratic,
     problems are going to manifest.
   • Know how you will handle conflict. If you simply can’t agree on something, who will prevail? You may agree to
     turn to a board of directors to help with conflict resolution; more dramatic measures could include informal or
     even binding arbitration.
   • Don’t depend on a partnership agreement to protect you from someone you don’t trust.

Keep things current
Periodically review and revise your partnership agreement if necessary. You may find that you began your partnership with similar backgrounds and skill levels, and that during the course of growing the business, your rate of professional development may differ from that of your partner’s. Or market conditions may force operational changes you had not originally anticipated. To maintain a viable business, it’s critical that you recognize and address these issues before they become catastrophes, and your partnership agreement can be the vehicle by which you accomplish this.

Finally, keep this very important reality in mind: When two entrepreneurial personalities are combined, there is a tremendous amount of strength and energy—but it must be focused in the same direction, or it will tear the relationship apart. A good partnership agreement will guide you through the good times, provide you with a method for handling problems, and serve as the infrastructure for a successful operation.

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