Not all startups are solo endeavors-lots of small businesses come about as the result of a partnership. In a partnership, you each bring unique strengths to your business, you have multiple people to share the workload, and you get the two-heads-are-better-than-one bonus. Of course, there’s a downside-you’re not going to get along with your partner 100% of the time. You may have different visions for the business, for example, or disagree about how much to borrow or where to spend it. You may butt heads over employment policies or how one partner wants to bring a dog to the office but the other is allergice – even little issues can add up to big trouble when there’s a business on the line.
Noam Wasserman, author of the The Founder’s Dilemma: Anticipating and Avoiding the Pitfalls That Can Sink a Startup (The Kauffman Foundation Series on Innovation and Entrepreneurship), reports that a staggering number of new businesses – up to 65% – fail as a result of co-founder conflict!
And here’s the thing – conflict is going to happen. There’s no perfect partnership and at some point, you’re going to have to deal with a disagreement. You can just start up your business and hope for the best, but then you’re just hoping that you and your partner can talk it out and come to a happy resolution. It’s a lot safer (and easier on both of you) to start out with a partnership agreement.
What Is A Partnership Agreement?
A partnership agreement is a contract between two or more partners in a business. It’s a way to make sure everyone understands their rights and responsibilities up front in order to help head off problems before they happen. The partnership agreement can cover issues like how a partner can leave the business, how much the business can borrow, how profit will be distributed, and more.
By creating a partnership agreement up front, you’re forced to address important issues up front and make sure you and your partner are on the same page. You don’t want to find yourself 5 years down the road fighting over how much of the company you own. Put it all on paper up front.
So, what goes into a good partnership agreement?
Note: A partnership is a legal document and should be drafted with an attorney’s help. This article is intended to provide helpful information but not legal advice.
The Partners’ Ownership Interests and Authority
The partnership agreement should clearly lay out each partners’ ownership interests in the company. Is it a 50/50 split? 80/20? You need to figure out how much of the company each partner owns and set it down in writing. You’ll also need to detail what each partner is contributing – cash, property, or services, for example.
You’ll need to set out the partners’ rights as owners. Who casts the final vote in case of a disagreement? Can a partner sell their part of the company or pass it along to their heirs? If one partner wants to leave, how is their portion of the company split up among the other partners, and where does the cash to buy them out come from? If there is a minority owner (less than 50%), how can they protect their interests when they disagree with the majority?
Some partners opt to allow other partners carte blanche to make all decisions on behalf of the business. Some partners request that all partners get formal consent from the other partners before making important decisions on behalf of the business. Decide which strategy works best for your partnership and include that in your agreement.
If you decide that partners need the consent of other partners before making binding business decisions, then work out ahead of time how that consent will be dealt with. Will you require a partnership vote? What situations would trigger a vote? Will smaller businesses decisions be subject to voting or just larger ones? Include these specifics in your partnership agreement so each partner is clear on their respective authority about small and large business decisions.
You should also consider issues that aren’t directly related to your line of business. For example, it’s not uncommon for a partner to borrow cash from the partnership. Will your partnership allow that? What are the terms and restrictions? Will you allow family members to work for the company and, if so, what are the rules on qualifications and hiring and firing?
Managing the Money
One of the most important sections all small business partnership agreements should include is each partner’s portion of the business’s profits and losses. How the money will be divided up may not be the same for each partner, so it’s crucial to clearly delineate these details in your written partnership agreements.
Consider the following questions when drafting this section:
- How will your business allocate profits? How much will go to the partners and how much will be reinvested?
- How will your business handle losses?
- How will your business deal with draws?
- Will profits and losses reflect each partners’ percentage stake in the business?
- Will each partner take regular draws from the business?
- How often will profits be distributed to each partner?
You’re going to want to spend a lot of time and thought on this area, since money tends to cause conflicts. And in a worst-case scenario where you end up in court, you want all of the details of your agreement set down on paper. In fact, this can help you avoid court altogether since everyone can simply go back to the document to resolve conflicts.
Running the Business
Partnerships can take a lot of different forms. Sometimes, one partner will provide cash and another will run the business. Sometimes, both partners run the business equally. Sometimes they split up duties, like one partner handling the operations and the other handling the finance. And remember that partnerships can involve more than two people, so there are a lot of potential options.
With that in mind, you need to make sure that all the necessary work is being done and nothing is falling through the cracks. That means assigning responsibility for all that work to the various partners (including the authority to hire and fire). You’ll want to include that in your agreement.
You should also include managerial duties shared by all partners. For example, you may want to require all partners to sit down for a meeting every week or month to check in, raise any concerns, and generally stay up to date on what’s going on with the business. You may want to require all partners to meet with an estate planner and draw up a will to protect the business.
One of the most important aspects of a well-thought out contract is the fact that it can help prevent bigger conflicts before they devolve into costly litigation. When you talk through everything and come to an agreement beforehand, you’re a lot less likely to have a nasty blowup down the line over how you’re allocating your profits. But there’s no such thing as a perfect contract and at some point, you may find that you’ve understood things differently or that one partner simply feels that part of the agreement is unfair.
That’s why we include sections on dispute resolution in a partnership agreement. Make sure there’s a clear process set out for how you’re going to handle things if there’s a disagreement between partners. That could take a lot of forms; some kinds of disputes may be best handled through mediation or arbitration while others may come to a vote of all the partners. You’ll want to cover a wide range of disagreements, from management decisions to profit allocation to investment decisions to a partner leaving.
Change in Business Size or Structure
Small businesses often change size or structure, either due to a planned event (new partners) or unexpected one (death or illness). By clearly specifying what will happen in the event of loss of a partner, addition of a partner, or business dissolution, you’ll be able to circumnavigate these key business changes without additional strife.
As small businesses expand and grow, some partnerships opt to add new partners. Does your business anticipate adding additional partners down the road? If so, what procedures will you follow to add these new partners? What roles and responsibilities will new partners have? How will new partners share in the profits and loses?
Just as small business should anticipate growing with new blood, they should plan for the inevitable loss of a partner through either death, firing, or voluntary departure. Under what circumstances can a partner be forced out? What happens in the sad event that a partner passes away? What if a partner wants to leave voluntarily? Does your business have a structured buy-out plan?
You may also decide to change the structure of your business from a partnership to a corporation. Your partnership agreement should address how that decision could be made and how the transition would be handled. For more details on how to handle business changes, visit Nolo’s resource: Plan Ahead for Changes in Partnership Ownership.
Partners on Paper
It’s always a good idea to write a contract down and a partnership agreement is no different. You’re going to put a lot of time and work into your business and it’s better for everyone involved if you sit down up front and agree on how you’re going to handle things. The fewer surprises, the better! So grab your partner and your attorney and think hard about what your partnership is going to look like.