Setting up and running your small business with a business partner has many pros, such as increased capital, more available labor, and greater potential profits. Done well, a business partnership agreement can be a lucrative and successful way to start up a small business.
Business partnerships can often be between friends or family members. These are people you know well, trust, and are comfortable working with. Those are all good things to have in a business partner. But money can put a strain on even the strongest relationship. You may find that you disagree about the track the business is on or the way you’re managing your finances. You may find you have different opinions about hiring and firing employees or about bringing in new partners. You may have trouble dividing your responsibilities. Basically, there are a lot of things that can cause disagreements in a business partnership.
The most important tool for navigating those tricky waters is to go through the process of negotiating a business partnership agreement. The process itself forces you to think about those issues, hammer out your differences of opinion, and formalize the whole thing so you both know what you’re getting into. That protects you, your partner, and the company. Ideally, you want to have these discussions before you get too far in business together—when you’re on good terms with one another, not when someone is already upset or something has already gone wrong.
So what goes into your business partnership agreement? There may be certain issues specific to your business, but there are certain broad categories that every partnership agreement should cover. Let’s take a look at those. Afterward, we’ll dig into how to go about negotiating a business partnership agreement with your partner.
Drafting a Written Agreement
Legal and business experts advise that all business partnerships should be formally memorialized with a written business partnership agreement. You may think that your business is too small or too new to need a business agreement. The truth is that all businesses—regardless of size, number of partners, age, or revenue—should have a well-drafted, complete business partnership agreement.
This agreement will prevent financial and legal disputes down the road, as well as detail a financial and operational roadmap for how business operations will run. How do you get started working out terms for your partnership agreement?
Step One: Decide on Mutual Goals
A successful business partnership has three key components. The business partnership needs to take into account your own interests, your partner’s interests, and the overall interests of the business entity.
Before drafting a business partnership agreement, you and your partner will need to do some homework. Decisions on all mutual business goals should be made first.
Discuss Projected Business Growth
The matter of business growth should be mutually agreed upon. What are the growth goals for the business? How fast do you want the business to grow? How will that growth be funded? How will capital be used to grow the business? How will debt be used to grow the business? Are you willing to branch into other areas or do you want to stick to your core business areas?
Assess Profit Taking
A second mutual goal to decide upon is the issue of profit taking. How will the business profits be distributed? Will each partner share equally in the business profits? How often will payments go out?
This is also a good place to talk about certain employment policies. It’s very common for small businesses to hire friends or family members, or to have those folks come in from time to time to help out. You need to work out whether you’re happy hiring family members and friends and how you’re going to handle it if one of those people ends up being a bad fit for the business.
Protect Your Own Interests
In any business arrangement, it’s important to make sure that your own interests are protected. You should view the business as its own separate entity that you’re investing in. That means you need to plan for certain long-term issues. What is the process for bringing in new partners? What happens if one partner wants to leave the partnership or buy the other out? By putting procedures in place ahead of time, you can make sure that process is fair and sensible. That protects both the partners and the business itself.
Be Clear About Goals—and Conflicts
In an ideal business world, your goals, your partner’s goals, and the business goals would all align. However, the world is not perfect, so you need to address any conflicts early on.
You should assess whether or not you have personal goals which run counter to your partner’s or to the overall health of the business. You likely will, so don’t be discouraged when you identify areas of potential friction. For example, you may want to pass the business on to your children and your partner may not want your children involved. Or your partner may want to eventually expand into other cities while you’d rather focus closer to home. When you find personal goals that run counter to your business partner’s or the business, this an area where you both need to compromise for the health of the business and to allow for lifestyle differences.
Take the time to think about what your personal goals are and how they fit with the business. Then you and your partner can sit down and explore those plans, identify potential conflicts up front, and come up with ways to approach the different goals together.
How Will Business Conflict be Handled?
No matter how aligned your interests are up front, there’s going to be a conflict at some point between you and your partner. You should include terms in the business partnership agreement that clearly outlines how the business conflict will be handled down the road. Those formal procedures can help you take the personal edge out of the issue and bring everyone into a professional state of mind.
Make sure that you include provisions for situations in which you simply can’t reach an agreement on your own. Third party mediation is a good option; an impartial judge can help both sides see a little more clearly and may be able to spot novel solutions.
Negotiating Your Business Partnership Agreement
As discussed, compromise is key to any successful and viable business partnership. There will be areas that you will need to compromise on when negotiating your business partnership agreement. It can feel a little strange to go into negotiations with someone you’re on such good terms with but remember that it’s a lot better to have these discussions in that state of mind than when you’re in crisis conflict mode.
Know Your Personal Deal Breakers Before Beginning Negotiations
When entering into any negotiation, each person has their own “must haves” and “deal breakers.” It’s crucial to know what those must-haves and deal breakers are so that you can set up a mental “hard stop” for yourself on important issues.
The only way to get what you want from any negotiation is to know your own personal endpoint: Where will you draw the line? You may want 50/50 partnership and won’t settle for less. Or, you may want full control over the legal aspects of the company. Or, you may want the bigger office space.
Articulate what you feel strongly about and will fight for versus what you’re willing to give up in order to reach a mutually agreeable arrangement. Whatever your must-haves and deal breakers are, know where you will ultimately draw the line at negotiating. From there, virtually everything else is fair game for negotiations.
Clarify Ownership of All Property Before Negotiating
Property ownership and use can be a sticky issue when it comes time to negotiate a business partnership agreement. Both you and the other party have amassed individual property prior to entering into the partnership. Before you begin negotiations, each party must identify, inventory, and value their own property.
Note that the term “property” does not apply only to physical, tangible property, such as real estate or business equipment. Property should also encompass all intellectual property each party brings to the table. Inventions, patents, and copyrights should also be included in your comprehensive property inventory since intellectual property can potentially add significant value to a small business. For a detailed discussion of the various types of intellectual property, visit our resource Definition of Intellectual Property.
You need to make sure you know what belongs to whom before you go into this negotiation (and you’ll want to negotiate who gets what in case of a breakup). That way, if negotiations fall apart, you don’t have to worry about one partner unfairly walking away with valuable physical or intellectual property and setting up shop on their own.
Discuss and Set Mutually Agreed Upon Goals
Once you’ve done your homework and have the goals and background info you need to be laid out, it’s time to come to the table with your partner. It’s always helpful to start with the positives: your mutual business goals. Considering that you’re in the process of starting a business together, it’s likely that you’ll have a lot of goals in common. But don’t just let this slide because it seems easy, either. You need to make sure you clearly articulate your goals and clearly understand theirs. Ask a lot of questions. Give thoughtful answers. Take the time to make sure you’re on the same page. And when you find places you don’t agree, take notes so you can address them.
Use Your Agreements to Address Your Conflicts
You’re going to have areas in which your goals or ideas conflict with your partner’s. It doesn’t mean you can’t work together, but it does mean that you need to hammer out those details now and put them in writing. This is where the compromises are going to happen. Chances are that neither party is going to get 100% of what they want, but that’s just the nature of working with other people. You already have your mutual goals set out, so you can refer back to those as an aid for compromising in some of the areas where you disagree.
And if you do find that you have differences of opinion that absolutely can’t be reconciled, it’s a lot better to know that before you’ve got the whole operation up and running.
Discuss What Will Happen Upon Partnership Dissolution
Once you agree on your goals and methods, a lot of the hard work is done. But the process isn’t over. You both need to acknowledge that a time may come to end the partnership. Business failure is possible, or one partner may want out, or both partners may decide to sell the business. It’s important to be aware of this and to talk about it.
You’ll need to decide how things go in case the partnership dissolves or changes. That includes bringing in new partners, one partner selling or buying out, selling the whole business, or dissolving it. Talk about how those decisions get made and what sorts of limitations you want to put on those processes to protect everyone’s interests. For example, you’ll probably want the right of first refusal if your partner wants to sell. You may also want to have the right to approve a potential outside buyer.
Two Heads Can Be Better Than One
Starting a business with a partner can be exciting and rewarding—or disastrous and traumatic. The trick to the former is creating a clear, strong business partnership agreement up front so everyone knows the score and has committed to well-defined business goals and processes. This is a situation in which an ounce of prevention is worth a pound of cure.