IRS figures show that millions of people go into business with at least one other person in a partnership. However more than two out three fail to survive, according to AssociatedContent.com. This is where the partnership agreement plays an important role. They are also known as shareholders agreements or operating agreements for a corporation and LLC respectively. Within the scope of the agreement, you and your partners can decide beforehand what is deemed equitable and fair in the event of a split, in what is known as an "exit strategy". While exit strategies play a role in all types of businesses, certain issues crop up more frequently when two or more come together to form a business.
Here is a possible scenario of a business which did not work out an exit strategy. One of our clients, Sheila, decided to start baby's clothing line with her college roommate, Kristen. They put together a corporation. Under the terms of the shareholder's agreement, Sheila financed the company while Kristen was responsible for the design and marketing of the clothing line. Fast forward a year, Kristen was fast outspending whatever money the company had on baby showers, expensive trunk shows and overpriced baby clothes. Sheila asked for a pause or a time out to take a serious look at how the money was being invested, but Kristen felt that Sheila was questioning her abilities and stepping over her boundaries. That, in turn, upset Sheila who wanted to stanch the money outflow to direct funds towards more meaningful purposes. Unfortunately, these two business partners did not have pre-established means to resolve the disputes nor did the shareholder's agreement have any provision to handle a buyout by either of the business partners. Unfortunately for Sheila and Kristen, a high-cost litigation ended up destroying both the company and their long-time friendship.
Avoid this nasty outcome by taking steps to spell out why an owner would want to leave a firm. If that happens, what is an equitable price for his or her interests in the company? There are a whole host of reasons why something like that should happen, but here are the more common ones.
1. Involuntary Exits. These include death, divorce, and disability. Most people don't choose for these events to happen. But they do, and they have a collateral effect on the company. If an owner dies or gets divorced, you could find that the former owner's spouse inherits the shares and becomes your co-owner, continuing to expect the same salary and profits from the business. Disability (physical) or incompetency (mental) of a business owner can often result in a greater financial drain than death unless the necessary provisions and disability insurance funding are put into place. How long can the business afford to pay the salary, benefits and profits of an owner who is too disabled to work or make a financial contribution to the company?
2. Resignation or retirement. A business partner sometimes just wants out either because there is a better opportunity elsewhere or because the person wants to sail around the year in pursuit of a long-held desire. Maybe he or she wants to retire. The partnership agreement should clarify the process and means to buy the stake of the leaving partner.
3. Kicking a Partner Out. Unfortunately, sometimes nasty things happen, such as a partner is found stealing money from the company. Perhaps the business owner is guilty of sexual harassment and refuses to stop. When such intolerable situations occur, it is time to kick the partner out. The partnership agreement should be clear as to what events would justify sacking a partner.
4. Conflict. Many business partners overlook the need to build into the partnership agreement provisions for amicably settling disputes, big or small. Otherwise, a deeply divisive conflict could deteriorate into a deadlock which can only be broken by dissolving the company.
5. Worth of a company. The value of a company is one of the most important items to be addressed in a partnership agreement. The business owners must lay out in the exit strategy how to establish the worth of an owner's interest when the occasion arises. Questions to address include "what is fair value" and "when do I have to pay for it?" Establishing a means beforehand for valuing a company gives all business owners peace of mind that should the occasion arise, they will receive an objective and fair price.
A partnership agreement should include procedures for conflict resolution and methods for establishing the value of a firm as well as methods of valuing a firm should the partners decide to split or buy out another's interest. Work with an experienced attorney to craft a successful exit strategy to reduce risks, minimize conflict and maximize gains for all shareholders.
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