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Don’t sign a partnership agreement without reading this first

Posted by Kanika Sinha

February 17, 2022    |     6-minute read (1017 words)

The purpose of a partnership agreement is to provide answers to questions that may arise in the course of business and thereby prevent problems among the partners down the line. 

Statistics consistently show that about 70% of business partnerships will fail over time. This means it is imperative that a partnership agreement be in place to address misunderstandings and fractious disagreements and provide for a manageable dispute resolution process. 

Despite its importance, many business disputes share a common missing element: a partnership agreement. After all, in the early stages of launching a business, founders may be too busy to allocate the time to spell out upfront everyone's expectations and responsibilities. 

Founders often see their business partners as close friends and believe nothing can go wrong since they’re working with “their” people. If a dispute happens, they think they can easily work it out – after all, that’s what friends do. 

But this type of thinking fails to acknowledge that even trusted partners have fallings-out, and sometimes handling them requires more than a cozy chat. Remember the world's biggest typeface lawsuit between former business partners Tobias Frere-Jones and Jonathan Hoefler, who did not have a written agreement?

What if something doesn’t go as planned?

Although the question of “what if my partners do not do what is agreed?” may not align with the goodwill spirit with which partnerships are formed, unexpected conflicts or dissent between partners can put a strain on the relationship. This is where a comprehensive and clearly laid-out partnership agreement with the right clauses and response measures for breaches by any partner can come to your rescue.

It is important to note that while having a partnership agreement in place is better than having none at all, an agreement that fails to include required provisions can still leave you exposed and end up costing you a fortune. 

What your partnership agreement should include?

In its simplest form, a partnership agreement is a legal document that dictates how a business will operate under two or more people. There are free templates online you can use to draft your own partnership agreement, but the services of an experienced partnership attorney can be invaluable. While items related to the partnership such as its name, purpose, formation, responsibilities, duties, and decision-making are boilerplate, it has to cover a lot more ground than that. 

Below are 10 terms to address in your partnership agreement:

1. Capital contribution: How much money or property will be put up by each founder at the start of the business, and will this be a capital contribution or a loan to the business? If the business needs more money down the line, will each founder be obligated to contribute up to a certain dollar amount?

In addition to delineating what each partner will put forth in terms of money, the agreement may also need to stipulate what each will contribute in terms of time, effort, customers and equipment.

2. Decision-making: How will key decisions be made at the firm, and with whose approval? Do the founders or shareholders need to sign off, or both? How will day-to-day business decisions be made?

3. Ownership: What percentage of the business will each founder own at the outset? This percentage isn’t always going to be equal; a founder who comes up with the business idea or the bulk of the capital is likely to get at least 50% ownership. How will ownership change as new capital is invested into the business, whether by the founders or external investors?

4. Titles and roles: The agreement should explain the titles and roles of each partner, including whether a role is part time or full time and whether roles can be changed over time. Will the founders have employment agreements? If yes, what will be the terms of their employment, and how can they be terminated from employment? Will they be granted severance benefits? 

5. Compensation: The partnership agreement should describe the salary and benefits that each founder will be entitled to for their role in the business. It may also need to address whether remuneration be deferred until the business is beyond the early stages in order to preserve capital. 

6. Dissolution or sale: The partnership agreement should delineate the steps that must be taken to legally dissolve or sell the business. It should also stipulate the percentage ownership vote required for this to happen.

7. Withdrawal from the business: The agreement should cover the actions to be taken if a founder no longer wishes to be active in the business. Will the company have the right to buy back his or her shares, and if yes, at what price? Will there be restrictions on competing with the business after withdrawal? And in the event a partner dies or becomes disabled, what will happen to the partnership? 

8. Dispute resolution: This clause should spell out how disputes will be handled by the partners. Will the agreement require confidential binding arbitration or mediation between the parties as the initial step in dispute resolution? Keep in mind that if a dispute gets litigated, lawsuits not only drain the coffers, but they also become public record and can hurt your reputation.

9. Worst-case scenarios: This clause should spell out enforceable protocols for obscure and unlikely doomsday scenarios. While discussing worst-case scenarios may be unpleasant, it is very important to consider this clause objectively and collaboratively with your partners. The goal is to set the stage for breakups to proceed as cleanly as possibly in the event of such a scenario. 

10. Amendments: The document should prescribe how the partnership agreement can be amended. What type of vote is necessary to incorporate the change? Which changes require a majority vote, and which ones mandate a unanimous vote?

Takeaway: Writing a comprehensive partnership agreement will take time, money and definitely some extra paperwork. While it may be hard to imagine that things could ever go wrong with a trusted partner, you should focus on the potential legal battles and pain a nonexistent or ill-conceived agreement could cause and prioritize finalizing the agreement.

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