Why You Can’t Afford to Forego Partnership Agreements (Even with Family!)

We’ve all heard the warnings. “Whatever you do, don’t go into business with friends!” Or “Never start a business with family!” These warnings, often intended for your best interest, aren’t altogether fair. In many cases, those who warn you about such a partnership had a bad experience. And many times, this happens because they never had a formal partnership agreement in place. 

A partnership contract is an absolute must, anytime you go into business with someone else. Whether you’re starting a digital marketing company with a cousin, launching a pet-sitting side gig with a friend, or joining forces with a former colleague to launch your own consulting firm, you need this vital agreement in place.

Partnership agreements are legally binding contracts created to protect each partner’s investment. They also clearly define the responsibilities and obligations of each partner. Well-crafted partnership agreements also spell out the purpose of the business and include details about partner contributions and voting rights. In addition, a partnership contract will provide the course of action that will ensue, should a dispute occur.

A carefully drafted partnership agreement can be the saving grace, designed to avoid miscommunication, and prevent legal problems. It keeps your business afloat, even when you and your partner(s) butt heads.

Here are four areas to cover in your partnership agreement.

Business Ownership

Your partnership agreement should spell out exactly who owns what percentage of a budding business. A fifty-fifty split can simplify things; however, in many cases, one partner will provide more of the initial investment into a business.  In this case, the majority partner may decide to take on more of the day-to-day responsibility for the business, and more of the profits, in exchange for their majority investment.

However, the opposite may be desirable. One partner may want to put up the bulk of the initial capital to launch the business, but in return, are less responsible for operating responsibilities.  You can customize your business ownership split however you’d like as long as all partners agree.  When determining business ownership, you’re laying the groundwork for who gets what, if the business is sold. 

Control of the Company

Your partnership agreement should detail how major decisions concerning the company can be made. A smartly crafted partnership agreement will include limits on the type of decisions that can be made, without the other party’s consent.  For example, a partnership agreement frequently includes a clause limiting the amount of money that can be spent, without unanimous agreement on the amount, and use of the money. 

Partnership agreements should also include detailed language on how changes to services the business provides, or products it sells are made. In other words, a partnership agreement can prevent one partner from making a unilateral decision to add new items or remove certain services. 

Control of the company also extends to things such as the location of the company, the protocol for bringing on a new partner, the hiring and firing process, and/or closing the company without the full consent of all partners. 

Control of company issues most often arise in 50/50 partnerships. So if you’re launching a business with a family member or friend, and you are equal partners, the partnership agreement needs to spell out exactly how the company is to be controlled.

Partner Liability Parameters

It is important to include liability in your partnership agreement.  Liability will depend upon the structure of your partnership (general, limited, etc.). In a general partnership, for example, partners will share both liability and responsibility. In limited partnerships, however, some partners may only be initial investors, thereby limiting their liability. 

Your partnership agreement should spell out who is liable in the event of legal problems; this includes lawsuits, or tax liens.  For help in determining liability, you may want to consult a business attorney, to ensure all partners are protected to the extent that they need. 

Details on Dissolving the Business

The reality is, that despite your best efforts, businesses can and do fail. You need your partnership agreement to detail the dissolution process. This protects all partners if a business needs to close, or if one partner wants to exit the business.

Friends and family often go into business together because they trust one another, and/or enjoy working with each other. However, a variety of external issues or forces can lead one or more partners to decide to leave the business. If you don’t have a dissolution clause in your partnership agreement, the process of a partner leaving, or the business closing can be messy or contentious.

To avoid arguments over the end of a business, consider adding specific terms to your partnership agreement. These may include things like prohibiting one partner from selling their stake in the company, without offering the other partner a buy out opportunity.  Partnership agreements may also include specifics concerning the transfer of ownership in the event of the death of one of the partners. 

Dissolution terms in your partnership agreement are also important; these terms make clear what happens to the assets of a company if both parties want to dissolve the business.

You may be going into business with your best friend since childhood, or someone you don’t know particularly well. In either case, you need a legally binding partnership agreement. After starting a business, it’s smart to safeguard your company (and relationship with your partner) with a partnership agreement.  

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