When business 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 partnership 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 business partnership 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 business partnership agreement can manage these expectations and give each partner confidence in the company’s future. This article discusses seven reasons your business should have a written business partnership agreement.
What is a Business Partnership Agreement?
A joint stock company agreement is a written agreement between the company’s owners. 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 business partnership agreement. This article refers to all three collectively as a business partnership agreement.
When Should Business Partners Get a Written Business Partnership Agreement?
The ideal time for partners to enter into a business partnership agreement is when the firm is set up. This is the best time to ensure the owners understand each other’s 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 a business partnership 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 Business Partnership Agreement?
The purpose of a limited liability agreement is to protect the owner’s investment in the company, determine the company’s management, clearly define the rights and obligations of the shareholders, and define the rules of engagement if disagreements arise between the companies. A well-written business partnership agreement reduces the risk of misunderstandings and disputes between owners.
To Circumvent Standard State Regulations
Without a written business 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 it is in their best interest.
Governing Company Owners
The written business 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 they 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 their uncertainties. 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 business 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 specialised 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 materialise, 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 business partnership agreement should include a process to remove such a non-performing or disruptive partner and restore their interest before their actions (or inactions) jeopardise 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 business 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, jeopardising 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 In Business Partnership Agreement
The written business 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.
Conclusion
That’s why it’s important that you and your business partner document your business partnership agreement 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 business 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.
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FAQs
Ques. Do you think there should be a written agreement when you do business?
Ans. Yes, it is crucial as it acts as evidence clearly stating the terms and conditions.
Ques. What a partnership agreement carries?
Ans. It carries the rules and regulations of a business partner and the voting provisions along with power division.
Ques. When is the best time to come into a partnership agreement?
Ans. The best time to enter into a partnership agreement is when the company is fully established and legally mentioned.
