Starting a business with a friend, colleague, or family member can feel relatively uncomplicated. Because trust already exists, business owners sometimes make the mistake of relying on verbal understandings rather than creating a formal partnership agreement.
Unfortunately, even the strongest relationships can be tested when money, responsibilities, and important business decisions are involved. Expectations can change, disagreements can arise, and circumstances that no one anticipated at the beginning can suddenly become very important.
A well-written partnership agreement helps address these issues before they become problems.
Why Have a Partnership Agreement?
A partnership agreement is one of the most important documents business partners can have. It establishes a clear understanding of how the business will operate and what each partner can expect from the others.
The goal is simple: put the important expectations, responsibilities, and procedures in writing from the beginning.
Doing so protects both the business and the people behind it. Rather than relying on assumptions or someone’s recollection of an earlier conversation, the partners have an agreement they can reference when questions arise.
What Should Be in Your Agreement?
A partnership agreement should begin by clearly defining the basic structure of the business. This typically includes ownership percentages, how profits will be distributed, and how losses will be handled.
These issues may seem obvious when the business is first formed, but assumptions can quickly lead to conflict if expectations are not documented.
The agreement should also define each partner’s role and responsibilities. For example, one partner might oversee day-to-day operations while another handles finances, sales, or growth strategy.
Responsibilities will likely evolve as the company grows, but establishing clear expectations from the beginning helps create accountability and reduces the potential for confusion or resentment.
Address Financial Matters Up Front
Money can become one of the biggest sources of tension between business partners, particularly when the partners have different expectations about compensation, distributions, expenses, or reinvesting profits into the business.
A strong partnership agreement should explain how profits will be distributed, how owners will be compensated, and how major business expenses and financial commitments will be handled.
It should also address an important question that is sometimes overlooked:
What happens if the business needs additional money?
Growing businesses frequently require additional capital. The agreement should establish whether partners are required to contribute additional funds, what happens if one partner cannot or will not contribute, and how additional investments may affect ownership or other financial rights.
Establish How Decisions Will Be Made
At some point, business partners are going to disagree. The important question is not whether disagreements will occur, but how they will be resolved when they do.
Some partnerships give each owner equal voting rights, while others assign decision-making authority based on ownership percentages or areas of responsibility.
The agreement should establish how major decisions are approved, which decisions require unanimous consent, and what happens when the partners reach a deadlock.
Creating those procedures while everyone is getting along is far easier than trying to establish them in the middle of a disagreement.
Plan for the Unexpected
A good partnership agreement should also address situations that no one expects—or necessarily wants to think about when starting a business.
What happens if a partner wants to leave? What if someone wants to sell their ownership interest? Can a new partner be admitted? What happens if a partner becomes disabled, dies, gets divorced, or can no longer participate in the business?
The agreement may also establish procedures for valuing and purchasing a departing partner’s ownership interest.
Planning for these possibilities does not mean you expect them to happen. It simply provides a roadmap if they do.
Creating Your Partnership Agreement
While basic templates are readily available, partnership agreements are rarely one-size-fits-all. Every business has different owners, responsibilities, financial arrangements, and potential risks.
Working with an experienced attorney and other qualified business professionals can help ensure that important issues are addressed and that the agreement complies with applicable laws.
Taking the time to create a comprehensive partnership agreement may seem unnecessary when everyone is excited about starting a business and getting along well. However, that is precisely when these conversations should take place.
A good partnership agreement isn’t created because the partners don’t trust each other. It’s created so everyone understands the rules before a disagreement ever occurs.
With those expectations established from the beginning, the owners can spend less time worrying about potential disputes and more time building the business.
Copyright: Business Brokerage Press, Inc.
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