When partners first set foot in the business, they are motivated and delighted to embark on this exciting new adventure together. At first, they agree on almost everything. We believe these new entrepreneurs will stay in business together forever or until they sell their companies for millions of dollars.
You believe that nothing is going well or that it is going to go wrong. They trust each other so much that they don’t bother entering into a written agreement. What can go negative in this scenario? Short answer: a lot!
The reality is that despite dreams of longevity and unwavering confidence, executives’ wants and expectations change over time. A written partnership agreement can manage these expectations and give each partner confidence in the company’s future. This article discusses seven reasons why your business should have a written partnership agreement.
What is a Partnership Agreement?
A joint stock company agreement is a written agreement between the owners of the company. If the company is a joint stock company, the agreement is an operating agreement. For an entity, the agreement is a shareholder agreement. If the parties form an open company, it is a partnership agreement. In this article, we refer to all three collectively as a partnership agreement.
When Should Partners Get a Written Partnership Agreement?
The ideal time for partners to enter into a partnership agreement is when the firm is set up. This is the best time to make sure the owners understand each other’s expectations and the company’s expectations. The longer the partners wait to sign the contract, the more opinions diverge on how to run the company and who is responsible for what. Establishing agreement at the outset can reduce contentious disagreements later, helping to resolve disputes when they arise.
A bitter lawsuit between former business partners Tobias Frere-Jones and Jonathan Hoefler, who had no written contract, over their multi-million dollar book deal.
Why Should Partners Sign a Written Partnership Agreement?
The purpose of a limited liability agreement is to protect the owner’s investment in the company, determine the management of the company, clearly define the rights and obligations of the shareholders, and define the rules of engagement if disagreements arise between the companies. Parties A well-written partnership agreement reduces the risk of misunderstandings and disputes between owners.
To circumvent standard state regulations
Without a written partnership agreement, company owners remain within standard state regulations. In California, this is the uniform limited liability company law amended for LLCs, the general corporate law for corporations, and the uniform partnership law for general partnerships. State laws are good enough for a pinch, but most homeowners need and want more control. By written agreement, the Owners may change the rules if the circumstances determine that it is in their best interest to do so.
Governing Company Owners
The written Partnership agreement must include appropriate restrictions on the sale and transfer of company stock to govern company owners. Owners may sell their shares to others, including competitors, without a written agreement specifying how the shares are sold. Even if the parties do not address what happens after the death or disability of the owner, the remaining owner may still make transactions with the spouse or other family members of the disabled or deceased partner.
Provisions governing when, how, and to whom shares can be sold or transferred can avoid these scenarios and the uncertainties associated with them. Well-designed, these clauses allow existing owners to retain ownership of the company and protect it from unwanted new partners.
Agree on important issues in advance
With the help of a written partnership agreement, partners can agree in advance on important decisions, such as dispute resolution. One of the most important provisions of the association agreement is dispute resolution. Partners may include a dispute resolution clause in their agreement requiring mediation and binding arbitration. Without it in writing, it is not possible to compel mediation or conciliation in disputes and avoid expensive and time-consuming litigation.
Removal of a disruptive or non-appearing partner
Although partners are capable of forming a business at best, the reality often does not match their intentions. Over time, owners who were best friends or close family members can drift apart and do things that put the business at risk. This can happen when a partner agrees to contribute equity in the form of specialized skills in exchange for a share of the business. An owner with little or no skin in the game is often not as supportive as those who contribute money and effort.
If the company does not grow as expected and these high returns do not materialize, this partner may be tempted to stop working for the company or, worse, work for a competitor. In this case, the other owners want to remove the partner who no longer participates but still owns part of the business. The partnership agreement should include a process to remove such a non-performing or disruptive partner and restore their interest before their actions (or inactions) jeopardize the business.
Adam Carolla Podcast Case is an example of what happens when friends enter into business agreements without a written contract.
To protect the business and investments of partners
The written partnership agreement must contain provisions that apply in the event of death, disability, or personal bankruptcy of the owner. All of these events could hurt the business. Without a written agreement on these situations, the owners may be forced to close the business, jeopardizing the investment of all partners. These scenario settings can add predictability and stability when they are needed most.
Other situations that should be addressed in a partnership agreement are non-competition and confidentiality. Provisions that prevent a partner from sharing the firm’s confidential information with others or soliciting work with a competitor are key to maintaining the firm’s competitive advantage and protecting all partners’ investments.
Protect minority shareholders
The written partnership agreement must contain provisions that protect minority shareholders. One such clause, the “tag with” provision, protects minority shareholders in the event of a third-party buyout. If the majority owner sells his share to a third party, the minority shareholder has the right to participate in the transaction and sell his share under similar conditions. The advantage of a minority owner is that he can avoid doing business with an unwanted new co-owner. This provision also ensures that all partners receive similar purchase offers and protects minority owners from much less attractive offers.
Protection of majority owners
The written partnership agreement should also contain provisions that protect majority owners. A “pull-down” clause forces minority partners to sell their shares if a third party buys. If the majority shareholder sells its shares to a third party, the minority shareholder must either (a) participate in the transaction and sell its shares to the same third-party buyer on similar terms or (b) buy the majority shareholder’s shares on similar terms to the conditions.
The advantage of the majority owner is that he cannot be forced to continue the business just because the minority owner does not want to sell. If the company’s purchase offer is made fair, the majority owner can take advantage of the offer, even if it goes against the wishes of the minority shareholder.
Businessmen enter into business full of optimism and good intentions. However, disputes between business partners are all too common and can destroy the entire operation. A well-drafted partnership agreement can protect owners’ investments, significantly reduce business disruptions and effectively resolve disputes when they arise, saving owners tens of thousands of dollars in legal fees.
That’s why it’s important that you and your business partner document your agreements from the start—to cover the positives (like profit sharing), the not-so-positives (dispute resolution), and the day-to-day running of the business. A written partnership agreement acts as a safeguard that protects both your business venture and each partner’s investment. In this article, we covered the most suitable reason why you should rely on a written business partnership for a safer future.