Put it in writing: The importance of a partnership agreement

By Bernadette Starzee
BridgeTower Media Newswires
 
So you and a partner or two are thinking about going into business together. There’s a lot of excitement, energy and hopes for a long, successful run.

But things do not always go as the partners envision. Sometimes, as the business grows and changes, the owners disagree on important matters, such as whether to hire or fire an employee or whether to purchase or lease real estate. Other times, there may be a dispute over how much the partners should be compensated. There may also come a time when one of the partners decides to leave the business to pursue other opportunities, or a partner unexpectedly dies or becomes disabled.

It’s important for owners to have a partnership agreement – a sort of business “prenup” – in case the unexpected happens. A thorough agreement will provide a framework for what to do in the event of various scenarios.

“The document details the economic and governance rights of the members vis-a-vis each other,” said Katherine Heptig, a partner in the corporate, health services and tax practice groups at Rivkin Radler. “It includes rules for voting requirements, the transfer of interest, and what happens if someone dies or becomes disabled.”

It’s advisable for the different parties to each have their own attorney to look out for their interests when drafting the agreement, said Kenneth (Casey) Murphy, a partner at Rivkin Radler who focuses on civil litigation and white-collar criminal defense.

“As the business gets more sophisticated, the original agreement can be amended,” Murphy added. 
—————

Management rights

A partnership agreement should cover several buckets, the first of which is management rights, according to Nicholas Venditto, a partner in the corporate/ securities group at Certilman Balin Adler & Hyman.

“You may have a partnership with two, three or more partners, and you need to decide how the business is going to be managed,” Venditto said, noting this includes both the day-to-day operations and the major decisions, such as whether to buy property or sell assets of the company.

“It wouldn’t be efficient to have all members involved in every day-to-day decision, so you might appoint one person to handle the day-to-day decisions,” Venditto said. “But for the major decisions, you might want unanimous consent of all the partners, or a two-thirds or three-quarters majority of the partners. Very often, it’s unanimous consent.”

Let’s say a company has two 50-50 partners and one wants to buy a piece of land and the other doesn’t.

“Without an agreement, you are at a deadlock, and the company will be standing still,” Venditto said. “But if you have the agreement and it says you need unanimous consent to take that action, now you know you can’t.”
—————

Capital/Profits

The agreement should detail how the company will be funded, including which partners will put in what amount, as well as any investment from third parties. It should also lay out how the profits will be distributed once they start rolling in.

“If $100,000 is needed, the two partners might put in $50,000 each, or one might put in $75,000 and the other $25,000,” Venditto said. “The one who puts up $75,000 might get three-quarters of the profit, but there is no one-size-fits-all. Agreements are customized to what everyone is trying to accomplish.”

Heptig said some clients will choose to be 50-50 owners even though one is putting up all the money. “The other might be putting in all the work, which is referred to as sweat equity,” she said.

Some owners might bring something else of value besides capital, such as special expertise or contacts.

Whatever the breakdown, it should be outlined in the plan.

“Very often, there are disputes among partners about what they own, and sometimes a non-owner claims to be an owner,” Venditto said. “The partnership agreement lays out very clearly who owns what.”
—————

Transfers

Members must decide what they will do if one of them wants to leave the partnership, or one dies or becomes disabled.

“If you want to transfer your interest to someone else, do you first have to offer it to the other members?” Venditto said. “If there is a disagreement over a major decision, can a partner be forced to sell their interest? If a member dies, do you want the membership to pass to his or her estate, or does the company have to buy him or her out?”

And if someone chooses to leave the partnership, the partners should decide whether he or she will be subjected to limitations under a non-compete agreement.  

Problems often arise over who the interest can be transferred to.

“You might want to be a partner with someone, but you might not want to be partners with that person’s husband,” Venditto said.
No matter what the agreement says, it’s subject to the partners coming to an agreement.

“If it says X and the partners agree to do something different, they can amend the agreement to provide for different scenarios that they might not have thought of,” Venditto said. “Maybe a partner decides he doesn’t want to be in business with the spouse and will want to be bought out, which the other partners might agree to.”
—————

Setting up the entity

In addition to drafting a partnership agreement, owners should give careful consideration to the entity type.

“Speak to an accountant or an attorney – preferably both – about which type of entity is best for your business,” Heptig said.

Whether a business is set up as a partnership, LLC (limited liability company) or corporation will impact the company in several ways, including how it is taxed.