April 6, 2022 | 5-minute read (979 words)
A partnership agreement's objective is to provide answers to questions that may arise throughout the course of business in order to prevent any conflicts among partners.
Statistics show that over 70% of business partnerships will dissolve over time. That means that a partnership agreement is imperative to address misunderstandings and provide a manageable dispute resolution process for acrimonious disagreements.
Despite their importance, many business disagreements share a common missing element: a partnership agreement that addresses resolution processes. But in the early stages of launching a business, entrepreneurs may be too busy to spend the time required to outline everyone's expectations and obligations.
Founders frequently see their business partners as close friends and assume that nothing can go wrong because they work with "their" people. If a disagreement arises, they believe they can simply resolve it — after all, that's what friends do.
This kind of thinking fails to recognize that even trusted partners have disagreements, and dealing with them sometimes necessitates more than a friendly discussion. Remember the world's largest font lawsuit involving former business partners Tobias Frere-Jones and Jonathan Hoefler, who didn't have a formal written partnership agreement?
What if things don't go as planned?
Although the concern of "what if my partners do not do what is agreed?" may not correspond with the benevolent spirit with which partnerships are created, unanticipated disagreements or dissent among partners can strain the relationship. This is where a thorough and clearly laid-out partnership agreement with the appropriate terms and response methods for breaches by any partner might prove to be a lifesaver.
It is important to realize that while having a partnership agreement in place is preferable to not having one at all, an agreement that fails to include needed protections can still leave you exposed and potentially cost you a fortune.
What should your partnership agreement contain?
A partnership agreement is a legal contract that specifies how two or more persons will run a business in its most basic form. There are free templates available that you can use to design your own partnership agreement, but it’s best to work with an experienced partnership attorney. While the partnership's name, purpose, formation, responsibilities, obligations and decision-making are all boilerplate, the agreements must cover many more areas than that.
The following are 10 terms to be considered in your partnership agreement:
1. Capital contribution: It's essential to know how much money or property each founder will contribute to the business initially, and whether this is a loan or a capital commitment. Will each founder be required to contribute up to a particular dollar amount if the company needs more funds in the future?
In addition to specifying what each partner will provide in terms of money, the agreement may also specify what each will contribute in terms of time, effort, customers and equipment.
2. Decision-making: How will critical choices at the company be made, and who will approve them? Do the founders or stockholders, or both, have to sign off? How will day-to-day business choices be made?
3. Ownership: What percentage of the company will each founder hold at the start? This ratio isn't usually equal; a founder who comes up with the business concept or raises the majority of the funds will likely receive at least 50% ownership. How will ownership evolve when fresh cash is put in the business, whether by the founders or external investors?
4. Titles and roles: The agreement should specify each partner's titles and duties, including whether a position is part-time or full-time and if roles can be altered over time. Will the founders have employment contracts? If yes, what are the terms of their employment and how may they be fired? Will they be eligible for severance pay?
5. Compensation: The partnership agreement should specify the compensation and perks that each founder will be entitled to for their position in the business. It may also need to consider whether payment should be withheld until the company has progressed beyond the early phases to conserve capital.
6. Dissolution or sale: The partnership agreement should outline the actions that must be done to dissolve or sell the business lawfully. It should also specify the percentage of ownership vote necessary for this to occur.
7. Withdrawal from the business: The agreement should specify what steps must be taken if a founder no longer desires to be involved in the business. Will the company have the right to purchase back their shares and if so, at what price? Will there be any limits on competing with the business following the withdrawal? What will happen to the partnership if one of the partners dies or becomes disabled?
8. Dispute resolution: This clause should specify how the partners will address disagreements. Will the agreement require secret binding arbitration or mediation between the parties as to the first step in conflict resolution? Keep in mind that if an issue is litigated, a lawsuit not only depletes finances, but they also become a public record and can harm your image.
9. Worst-case scenarios: This clause should provide enforceable processes for esoteric and rare apocalypse situations. While considering that worst-case possibilities may be unpleasant, analyzing this clause critically and jointly with your partners is critical. The purpose is to lay the environment for breakups to occur as smoothly as possible in the case of such a circumstance.
10. Amendments: The document should specify how the partnership agreement can be updated. What form of the vote is required to implement the change? Which modifications require a majority vote and which demand a unanimous vote?
Creating a complete partnership agreement requires time, money and most likely, ample documentation. While it may be difficult to foresee things going wrong with a trustworthy partner, you should focus on the possible legal fights and anguish that a nonexistent or ill-conceived agreement may create and prioritize formalizing the agreement.