Today we’re diving into business partnerships! Many businesses have more than one owner; you can spread the risk, add expertise, double your network, and share necessary tasks. It makes sense! Adding a partner, however, isn’t as easy as just signing someone new on. From business issues to legal structuring, we’ll talk about the important things you need to know!
Fundamental Business Partnership Considerations
Business partnerships often arise when a new company starts. They might also arise when a new partner joins an existing business owner within their company, or when multiple businesses comes together.
However your partnership starts out, there are a few fundamental “buckets” you’ll want to consider.
Bucket #1 – Decision Making & Control
Who makes the decisions on what kind of things? Who has voting rights?
There are various levels of decisions that occur in any business. There will be distinctions within the partnership for who is in charge of what. For day to day decisions, there is often minimal documentation. Partners usually have tacit agreements about areas of oversight in order to keep things moving.
Once we branch into larger areas, however, clarity becomes key. Imagine one partner is a ⅔ owner and is a ⅓ owner. Does the larger majority holder automatically control all decisions? Do they have the final say? If no agreement has otherwise been made, this will be the default setting. (Possibly with a couple of exceptions under state law.) Alternatively, you may have a supermajority or unanimity requirement. That would impede a majority owner from making decisions without a minority owner’s approval.
Questions of selling equity, hiring/firing key employees, incurring debt or acquiring other companies?
You need to be aware if one partner has more decision making power than the other. All parties within the business partnership should have clarity around the level of decision making control they have.
I provide my clients with a list of extraordinary transactions for the business partners to review as they consider business partnerships. These transactions include large decisions like bringing on new partners, spending a certain amount of money, or otherwise making larger decisions. It’s crucial for business partners to get clarity on these matters from the get go!
Additionally, you’ll want to consider equity. Will everyone in the entity have the same class of equity? It’s not uncommon to create an A Class for founders, and a B Class for others buying in later. However, there are so many equity and capital structure variations that they need to be tailored to your specific needs and desires. Keep in mind that this is something that must be decided and created, not something that automatically happens.
Bucket #2 – Economics & Cash Flow
Who holds the purse strings? How does the money flow?
Just because someone holds a certain percentage of a business does not mean they are entitled to that percentage of the split. (If three people own a company, it is not a given that compensation must be split into even thirds.)
For instance, within a business partnership there may be a consideration given for services or contributions in addition to ownership. Whether this is paid as a salary, as a guaranteed payment, or as an additional distribution, it is important to understand how each member of a business partnership will be compensated for their role in the company.
Will the compensation element be directly tied to ownership elements? Or are there other factors that may be just as important, if not more so?
It’s much better to gain cash flow and economic understandings from the outset, rather than assume that others are in agreement and find out later that there are resentments and confusion.
Bucket #3 – What ifs?
What if someone dies or becomes permanently disabled? If someone retires? What if someone wants to leave the business?
One important decision you should make within your business partnership is what will happen if a partner passes during their time as an owner.
If a partner dies and there is no written agreement, their share of the company will pass to their next beneficiary from their will. This could be a spouse, child, or relative. In an instant, your business could have a new business partner who, very likely, knows nothing about the business. For this reason, buy/sell provisions should be included in the operating or shareholders’ agreement for the business partnership protect the other living partner/partners from being forced into a business partnership in which they did not intend to be.
A buy/sell gives partners the right and ability to retain equity by purchasing it from the deceased’s estate. This is a powerful form of protection that can prevent a company from moving into the hands of an unintended party. It’s also a gift to the family, who is able to monetize their ownership and be compensated for their family member’s role. Ideally the estate or family receives fair compensation, and it’s a win/win for both parties.
In terms of being able to buy those shares back, we most often recommend a term life insurance policy that has been set up as a cross purchase. As a funding vehicle it won’t hurt the company’s cash flow, and allows partners to quickly compensate the family and retain shares via a buyback.
To hear more about how disability insurance can come into play, listen to the full episode.
Additionally, you’ll want to consider retirement expectations. Along with retirement criteria, you should discuss potential non-compete/non-solicit agreements. These would come into play if a partner leaves without retiring.
If a partner were to leave, what would happen with their clients? Is there a way to divide the business if members want to dissolve the partnership at some point? Are there buyout provisions in place?
The truth is, there are a lot of decisions to make when it comes to business partnerships. There are too many nuances to just pull a pre-formatted agreement off the internet. You can’t just use the one your friend used for their company. Like with the old Fram oil filter commercial: you can pay your attorney and other professionals now, or you can pay them much more later. That’s what happens when things weren’t done right the first time around. You end up having to clean them up or deal with a dispute.
Corey Kupfer is an expert strategist, negotiator and dealmaker. He has more than 35 years of professional deal-making and negotiating experience. Corey is a successful entrepreneur, attorney, consultant, author and professional speaker who is passionate about deal-driven growth. He is also the creator and host of the DealQuest Podcast.
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