You and your best friend (or brother, cousin, co-worker, etc.) come up with a great business idea for a dessert bar over drinks one night. Together you feverishly write down the business plan on a napkin. With her culinary talent and your background in marketing, it’s sure to be a success, right?
When two or more people begin a business for profit, the company instantly becomes a general partnership. No paperwork required. It is entirely possible to be in a partnership without knowing it.
Each individual partner is liable for all of the debts of the partnership whether they agreed to that debts, whether they knew about that debt or even if one of the partners said, “no” taking on the debt.
Unfortunately, general partners have lots of responsibility – and liability – to each other and to the business; especially when things go wrong. If you're thinking, “What could possibly go wrong?” Believe me, many business partnerships turn south and many once-friendly partnerships do unfortunately end in ugly legal battles. Therefore, general partnerships should have an ironclad partnership agreement that states the rights and responsibilities of each partner.
The Partnership Agreement
A partnership agreement in business is akin to the prenuptial agreement in marriage. Just as prenups are often precursors to wedding day bliss, partnership agreements should be signed, sealed and delivered prior to starting any business activities.
It's important to preserve the relationship and the business when starting a venture with a co-founder before the money starts rolling in. No money or time should be invested in the business before the terms of the partnership agreement are laid out.
The partnership agreement should indicate:
Each partners current and expected contributions to the business. It's important to make clear what the expectations are of each partner's time and capital contributions to the business, that way its obvious if one partner is not meeting the standard.
The power of each partner to make decisions and incur debt on behalf of the business. It is hugely important to determine the power of each partner and whether all major decisions need to be made jointly or if one or another partner should have exclusive decision making power in certain areas of business.
What happens upon the death, incapacity or withdrawal of a partner? It’s important to have an exit strategy in the event one partner is no longer able or no longer desires to remain a partner so that this does not trigger the dissolution of the business.
What happens upon dissolution of the business? It’s important to lay out the terms of what happens in the event that the business is no longer solvent.
How disputes between partners regarding business decisions will be resolved. This is especially important when dealing with two partners who each own 50% of the company. If the partners become deadlocked on a business decision, that could be the end of the business without a legally-binding dispute resolution strategy.
How compensation and profits will be handled. Everyone gets along in the beginning but once the company becomes profitable, it’s important to have clarity on what portion of funds will be used to compensate the partners, what portions will be reinvested in the business and what portion will be distributed at the end of the year.
Disagreements can arise from any of the aforementioned issues – and they do. It is unwise to attempt to save money on your businesses legal needs in general, but this rule of thumb applies even more to partnerships. Invest in a lawyer to draft your partnership agreement. A good small business attorney will see the signs of potential weaknesses in your partnership and be able to draft a tailored agreement that protects the company and provides a strategy to deal with the problems that may arise.
Once your partnership agreement is developed, you can start the exciting work of building your business, knowing that you and the business are protected.
This article was originally published in YFS Magazine.