There are advantages and disadvantages with starting a business with another person. The clear advantages are the ability to raise more capital, take on more work, have more brainstorming power, and someone who is just as passionate as you are to count on. Most people start businesses with a family member, a friend, etc., basically, someone trustworthy. You might be thinking, “If I trust this person, why do I need a Partnership Agreement with them?” That is an excellent question, and in this blog, we provide excellent answers why every partnership should always have a Partnership Agreement.
What is a Partnership Agreement?
Think of it as a contract, because it is (see our previous blog, Contracts 101). It’s an internal agreement between two partners that governs them and the company. A Partnership Agreement can include anything from divvying of work, owner draws and distributions, admission of new members, tax treatment, profit allocation, management duties, and more. Each Partnership Agreement will look different, crafted to meet the partners’ needs. Even though each agreement will have different clauses, every agreement should have at least the following provisions.
How does your company want to allocate ownership interest? Did one partner contribute more investment capital? Is a partner an expert and the other ones are not? Who is licensed to do what? For example, two friends start an HVAC company but only one of them is licensed to actually perform the work. Should they both get equal ownership or should it be distributed fairly amongst the owners. These are all good questions to ask. In general, most partnerships will consist of equal shares of interest.
There are the day-to-day decisions and then there are the hard ones. Most Partnership Agreements do not need to cover the daily operating decisions, such as a partner granting a day off to an employee or a partner giving the okay for overtime work. The longer you are in business, the more chances that you will encounter hard business decisions that will have a lasting impact on your business. Should you purchase a new office or equipment? Should you merge with another company? Should you start offering benefits, such as health, dental, and retirement? These are all decisions that would require a lot of time and thought, and you do not want your business partner to act hastily. Most Agreements will give each partner one equal vote when it comes to these decisions.
Transition provisions cover when an LLC member dies or leaves the company for whatever reasons. Without a Transition provision, the company may automatically be forced to dissolve. The Transition provision can lay out the requirements when such a situation arises. Using our example above, if a partner no longer wants to participate in the HVAC business, there could be language for a buy-out. This can happen in many ways, however, the most common one would be getting a current fair-market valuation of the business and paying the partner who is leaving his share.
Death or Disability
This is a more uncomfortable provision for most partners, and people in general. It may seem like something far off in the distance, but death and disability can happen at any time. Therefore, it is always best to be prepared. Who would inherit your shares of the company if you die? Who will take over your work if you are disabled? How will your interest and ownership in the company be affected if you can no longer perform the level of work you performed before your accident? Who would you like to have a say on your behalf, or to vote for you, in case of death or disability? Some agreements allow some time to pass after a partner’s death to purchase his interest while others may require an immediate payout of the company’s fair market value. Others may agree to a payment plan of say, two years at $2,000 a month.
At Thooft Law, we write and review Partnership Agreements regularly. We listen to your business needs, your vision, and how you desire to run your company. We draft and negotiate agreements that fit both partners. If you already have an agreement and are concerned with its validity or any specific provision, we offer contract review services as well. Attorney Thooft is an experienced contracts and business law attorney. For a free initial consultation, contact [email protected] or 651-364-7725.