We work with a lot of business owners on business partnership, getting them set up right, establishing them, and making sure they function the way they want. We are helping them by trying to align the partners, trying to make sure the economic interest work, and trying to maximize everybody’s wealth and value creation. But what are some things you need to think about in forming a partnership? What are the pitfalls? What are you on the lookout for when you’re setting up your partnership and negotiating? What are the things that you must cover to make sure that you don’t end up in litigation or otherwise, in an unexpected place?
#1 Once you’re in, how do you get out? Have you worked on an exit plan? Are there ways for partners to get in and out? We often talk about the fact that partnerships go into unexpected directions, and it’s hard to predict all the twists and turns that a partnership could go through. How do you exit in a partnership? How do you deal with the fact that life is going to change, and that some partners may want to leave at different times in the partnership agreement? You need to have effective procedures for changing the lineup of partners and owners whether those changes are coming from death, disability, divorce, disagreement, or just life changes.
#2 Expectations may be different. Different partners may want different things, and one thing we find often is that there are hidden expectations – things that are just in their head. Not where people are being vindictive or mean . . . it’s just that they are thinking different things – unspoken thoughts. People are coming in from different perspectives, and because of that, people may have different expectations. We need to deal with that upfront by planning ahead. We need to talk, and discuss, and write out plans so that we can make sure everybody has the same expectations. Going into a partnership with somebody when you’re both suddenly thinking different things concerning the partnership, can lead to real trouble.
#3 How do you get compensated? How do you pay partners for the work they’ve completed? This needs to be discussed upfront. You also need to look at differential inputs. Is one person putting in more capital? Is one person putting in more time? Is one person putting in more hours, and will those hours and capital require exchange over time? How do you make an effective compensation system that’s fair to everybody? This will avoid problems down the road. A lot of partnership disputes are when somebody feels that they’re not getting properly compensated.
#4 Liquidity. How are you making sure that people can get in and out of the partnership? We talked about the fact that people are going to change and they’re going to come and go, but how do you make sure people get paid? Some people are going to leave the partnership and they want to get paid. Having a partnership interest in a privately-held company often is not very valuable because there’s no market for it. Nobody wants to buy that, so you need to come up with ways to fairly treat your exiting partners or changing partners. You need to have liquidity systems in place.
#5 Changing rules. How do you change the rules of a partnership? What if things evolve? How do we change how the partnership works? How do we change how compensation systems work? We need to have flexibility in the partnership, but that also means we need to have ways of changing and evolving that’s fair to all, and we need to have some kind of voting system or other way of making sure that change is done correctly.
What’s been your experience with partnerships? What problems have you seen? What are you trying to avoid? Share in the comments below. Join the discussion.
This posting is intended to be a tool to familiarize readers with some of the issues discussed herein. This is not meant to be a comprehensive discussion and additional details should be discussed with your attorneys, accountants, consultants, bankers and other business planners who can provide advice for your circumstances. This article should not be treated as legal advice to any person or entity.
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R. Shawn McBride — R. Shawn McBride is the Managing Member of The R. Shawn McBride Law Firm, PLLC. Shawn works successful, private business owners in their growth and missions to make a company that stands the test of time. You can reach R. Shawn McBride at firstname.lastname@example.org or (214) 418-0258.
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