Vicki Ammundsen talks you through the ins and outs of business partnership agreements.
In all the excitement of starting a new business, sometimes the structure of the business itself can become secondary to the rush to create the product or service.
While this can be a dangerous approach for people looking to create lasting and successful businesses, it provides many lawyers with an excellent living.
So, for anyone looking to create a new business venture with other people, I offer this counsel:
For any new business venture it is important to be very clear on what the business actually is.
Some types of business can involve very different business models and numbers of partners. And if the partners are not agreed on a model and structure, it can be a recipe for failure.
Just as important can be the matter of how the venture might grow and, indeed, how long it is proposed to last.
Do all partners have the same plans for the future? If one partner only wants to operate a single outlet, when another wants to expand, there may be an insoluble problem.
Clear and robust partnership agreements are therefore the foundation for a healthy, equitable and successful business.
Start at the end
When a new business venture is being proposed and an agreement between partners is documented, it pays to start at the end. In other words, how will you get out? What happens when either the venture or the partners’ relationship comes to an end?
Business agreements – whether documenting partnerships, joint ventures, companies, franchises or any other form of business structure agreement – are fundamentally there to spell out how the partners propose to get along and, if or when they don’t, to spell out what happens next.
A fundamental aspect of a partnership agreement should be how it records the entry and exit mechanisms. These mean, on the one hand, what each party is contributing to the venture (money, skills, contacts, etc), why, and what it means for that party’s role in the business; and on the other hand what happens at the end.
The end can mean very different things. It can mean if the business fails or simply ceases operation and cashes up. It can also mean that one partner wants to leave while another partner (or partners) wants to carry on; or if successful, how the partners reap the benefits of that success.
Structure and liability
An important first aspect of going into business with someone is working out how the business will be structured and the associated costs and benefits.
The choice of structure will usually be based on three main considerations:
- How the parties want to meet their tax liabilities.
- What risk liability the parties are willing to accept.
- How distributions will be made.
The question of who will actually be involved in managing the business also needs consideration. Some ventures are effectively partnerships between managers and funders. This can have a big influence on issues such as structure and decision making.
The choice of structure also leads to the matter of how decisions will be made. Will decisions need to be unanimous? This will often be essential if there are two equal partners. Otherwise, will all parties have proportionate power to vote on issues? What happens if one partner is responsible for the funding, with other partners being ‘operational’?
Situations like this often create an imbalance of power because, after all, how do you value the relative contributions when each may still be critical to success in its own different way?
While it is common for there to be unequal positions where there are different types of contribution (for example, when a financial investor gets a return before others in some situations), if this is not understood and genuinely agreed beforehand there’s a very good chance it will become a problem later on.
Detailed termination provisions can help avoid expensive litigation when a business needs to come to an end, regardless of the reasons why.
Insuring and resolving disputes
Whatever you do with your partnership agreement, don’t forget insurance.
Insurance is a risk management tool and, in this context, some termination events can amount to unforeseen risks. Insurance is a useful tool to address termination events and provide buy-out options.
Insurances are commonly used as a protective mechanism in the event of the death or incapacity of a partner, if the other parties wish to carry on but do not wish to have to deal with the spouse, children or estate of the unfortunate partner, or to tie up valuable capital making an untimely pay out.
Another consideration is whether there will there be a need to arrive at a valuation on termination and how might this be conducted. An agreement should specify an appropriate, balanced and fair valuation methodology.
Breaking it down
The breakdown of partner relationships will usually be the culmination of disputes between the partners. One of the measures of any venture agreement is how it deals with decision making and, where problems arise, how disputes are to be resolved.
It is increasingly common for agreements to provide that disputes are to be resolved through forms of alternative dispute resolution such as mediation, usually in the first instance, or (and most commonly) through arbitration, and to avoid the courts.
But remember, arbitration clauses do not necessarily exclude all involvement of the courts, which may still be available in the form of injunctions (for example), or on appeal in certain circumstances.
Due diligence pays
Many ventures commence with the purchase of an existing business or franchise. When this occurs it is fundamental to undertake a comprehensive due diligence exercise to gain a full understanding of the business – how it has performed and is likely to perform, how it functions, what its assets and liabilities are, its markets are and, especially, what its risks are.
That said, when entering a new business with partners or investors it is no less essential to do due diligence. This should cover your partners: who they are, their qualifications to perform their roles, and whether they represent risks to their partners.
If someone else has developed the business plan and financial models, it pays to scrutinise them closely – not from the perspective of the upside that might be possible, tempting as that may be, but also the risks that it is too optimistic or just plain unrealistic.
Where possible, conduct ‘sanity’ tests – sometimes numbers that are too good to be true become more obvious when looked at away from the narrow confines of the deal itself.
Treat your legal and accounting advisers as allies, not adversaries. They’ve likely seen it all before and, while the messages may be couched as doom and gloom, if you can work through the potential downside the prospects of a successful venture can be significantly enhanced.
Sometimes due diligence will result in a decision not to proceed. Where that is the case, it can be good business too.
Vicki Ammundsen is director of Vicki Ammundsen Trust Law Limited. Email [email protected]