Talking to your business partner about how day-to-day business will be managed is an invaluable step in your business planning and road to success.
As change is one of the certainties of life, also talking to your business partner about the future, and what should happen if circumstances change, is important to provide each of you with peace of mind, and a level of certainty about the future.
All too often we are consulted when partners are in crisis because an unforseen dispute has arisen between them, or one partner wishes to exit the business, or because their existing partnership agreement does not reflect their true needs or wishes. A poor or outdated partnership agreement can sometimes be worse than no partnership agreement at all.
This article describes some of the issues partners should talk about, and address, in reaching a positive agreement about their partnership.
As a fundamental point, the agreement should reflect what percentage interest, or specific assets are owned by each partner. It should specify any commitment which has been made e.g. for initial capital investment, and set out a process for the control of any business loans to partners.
The agreement should provide some simple procedures for partnership meetings to take place (e.g. how many partners must be present before a meeting can go ahead and make decisions (quorum)), and whether a partner can be represented by a third party at those meetings. It may also provide that certain decisions need a higher level of actual partner approval than others (e.g. approval of an annual budget requiring 70% approval, or approval for the creation of any mortgage or security over the partnership assets needing to be by unanimous consent of the partners).
Remuneration and benefits
Any partnership agreement should clearly state the basis for partner remuneration and profit distribution, and any benefits to be enjoyed by partners such as vehicles (recording the range of vehicle models which can be requested, rules for replacement of vehicles, and payment of vehicle expenses).
Commitments required of the partners
Partners should consider whether the agreement should require certain positive commitments (e.g. to dedicate the whole of their time and attention to this particular business), or negative commitments (e.g. not to incur any financial liability without the authority of the other partners, or not to create a mortgage over the partnership assets without authority).
Admission of new partners
The agreement should govern how new partners may be admitted to the partnership (e.g. by unanimous agreement of all existing partners).
Leaving the partnership
This is the area which often causes most distress to a business. Partners should consider in what circumstances they should be entitled to leave the partnership, and whether there should be some time restriction on an exit, for example, not within the first five years. We frequently see circumstances where a partner has behaved in a way which is unacceptable to other partners, but because there is either no partnership agreement giving the non-defaulting partners rights to expel the defaulting partner, or the existing partnership agreement is deficient in its wording, the partners remain bound together, in dispute, and having to resort to mediation or litigation to resolve the matter. This can sometimes involve the provision of an unforseen and unwelcome “exit payment” to buy out a defaulting partner.
The agreement should be clear about what would constitute a default (e.g. loss of professional licence, criminal conviction, insolvency), how a defaulting partner can be expelled, and confirm the rights of the continuing partner or partners to purchase the defaulting partner’s interest. The method of valuation for an outgoing partner’s interest should be expressly agreed and recorded.
Restricting an ex-partner’s ability to compete
A partnership agreement is also useful to obtain legally enforceable covenants from all partners that in the event of their exit, they will not undertake activities which compete with the business, within a certain area and for a certain period of time. It is essential that these clauses are within the bounds of what Courts consider to be reasonable if they are to be legally enforceable.
A partnership agreement should contain requirements as to how any dispute is to be handled if the partners cannot resolve it between themselves. Compulsory referral to mediation is a useful clause to consider, as the process of mediation can often find solutions to problems which might otherwise seem overwhelming, without recourse to expensive and stressful litigation.
Discussing these issues, and reaching agreement can provide significant comfort and security to business partners. Having a properly drafted and legally enforceable partnership agreement or contract will provide very significant rights and remedies in the event that there is a partner exit, death or illness, default or other dispute. Businesses should review their partnership agreements on a regular basis to ensure that they remain relevant, and reflect the current needs and wishes of the partners as business, and life, moves on.