The Business Partnership Agreement

Why Most Partnerships Have No Solid Partnership Agreement

M any business partnerships are formed with only simple, boilerplate documents. People who decide to form a partnership can do it online for a couple hundred bucks. Lawyers, under pressure to compete with “fill-in-the-blanks” online services often resort to templates. Most partnerships under-estimate the value of two documents that could one day save their business and protect their life savings. Those documents are your operating agreement and your buy-sell agreement. Combined, these are usually referred to as the Partnership Agreement.

Having a boilerplate operating agreement is dangerous enough. There are many things that arise as a business succeeds that are not addressed by most operating agreements. When a situation is not defined in advance it presents the potential for conflict later. Conflict is most likely to arise if the business does well.

There’s a paradox. Most people think partnership problems arise when a business is struggling. In fact, the big tension comes with success.

For example, does your operating agreement specify how big decisions are made? If you want to buy a building and expand your business, and your partner wants to stay small, how is the decision made? I’ve seen operating agreements between 2 partners that specify a vote to be taken with the majority prevailing. How do you get a majority with 2 votes? Can you take company funds and buy a car without discussing that with your partner? Can your partner take all of the company cash and buy a vacation home? Both of those are possible, legal, and happen every day. I’ll bet your operating agreement does not prevent those things. It should.

No, you don’t want to be too rigid but you should set some decision making protocols up in advance. And, you should define a process to follow when there is no process for a given situation.

Having a clean, clear operating agreement can govern potential problems before they come up. I like to see agreements that require unanimous agreement on big decisions. Sound scary? If it does, maybe you shouldn’t enter a partnership.

What about this? Can your partner sell a portion of his interest to a third party? Maybe.

Buy-Sell Agreement

Many business partnerships don’t even have a buy-sell agreement. I counsel all my clients on the first day we meet that there are 2  threats that kill a partnership: Taxes and Partnership Disputes. These often occur together.

The Horror Stories

Talk to anyone who ‘used’ to be in a partnership and they will tell you about the stress and financial drain from their partnership problem. If the business survives a partnership dispute, few businesses do, it will be left cash-strapped after the ‘settlement’.

Ask and you’ll hear about the partner who died leaving his interest to a spouse who wanted to take control. There is the partner who cleaned out the cash and ran off with the secretary. And there is the partner who got married and the new husband expected to assume an active role in managing the business. Lots of things can happen. If your business partner dies, do you know who your new partner will be?

Without a good buy-sell agreement, many businesses fail when one of the many partnership issues arise. Problems start with a tense conversation between partners about some big decision. Eventually, the tension escalates until one partner hires an attorney. That forces the other partner(s) to ‘lawyer up’. Now, with 3 or more attorneys (the business’s attorney and each partner’s attorney) at work, costs begin to skyrocket.

Your buy-sell agreement should be rock solid, iron clad and specify how a partner is ‘bought out’ under every possible situation that might arise such as death, disability, non-performance or voluntary exit. The exact values for each person’s interest should be defined and updated often in advance of dispute. Rules governing buy-outs should be specified. It’s far easier to agree on these things when everyone is getting along.

If your partner dies, her interest can revert back to the business and the business can be required to pay the estate a fixed sum. That prevents the business from getting an unexpected new partner. You don’t have to get stuck with an incompetent relative.

There are too many situations for me to cover here. And most people have their own ideas about how they wish to handle each situation. That’s okay. The point is to get all the bases covered before there is a problem. You want each detail clearly defined. I have argued with attorneys about vague clauses like “in the event of a partner’s death, the business will pay the estate an amount determined by appraisal.” Sounds clear enough, right? So who makes the appraisal? What if 2 appraisals are widely different? What if the business owes taxes? I’m not knocking attorneys, we need them. But we also need much more iron-clad agreements than those generally prepared by attorneys. Consider this case. I recently helped settle a buyout of a rather large consulting firm. The buy-sell agreement called for three appraisals with the middle value being the final valuation. The firm was not doing well and one partner wanted out. Easy right? Get three appraisals, take the middle one and make ake an offer. I pointed out that getting an appraisal of a service business requires an audit. A ‘deep dive’ audit costs around $20,000. The firm must spend $60,000 to determine the value of this partner’s interest. That interest is worth about $30,000 but the selling partner was demanding the appraisals.

Let Me Help You

I offer consultations on developing operating and buy-sell agreements. Once we’ve walked through the possibilities and you’ve determined how each situation should be handled, your business attorney can draft the final documents. This process will not only save you a lot of money now, it could save your business later.  If your operating agreement is weak or if you haven’t created a buy-sell agreement that covers all situations, I recommend having that conversation with me.

We can usually get it done in a day and your interests will be protected for life. Most of the time we can do it with a video conference. But, even with travel, having me help you with these steps will be cheaper and better than having an attorney simply draw up documents. Once we have met, then your attorney can put your intentions into the proper legal wording for your state.

Don’t wait. CALL (530) 467-5690 and talk directly with Chris. Let’s get this done.