Tie Your Knot with Care: 5 Areas to Discuss Before Partnering

Entrepreneurial partnerships can be hard. If you have ever been in one, you know. I wrote earlier about the origin of the Company and the reasons to choose your business companions carefully. Choosing the right companion, or partner, is only the beginning. If you want to maximize the chances of your business partnership thriving and succeeding, you have to begin to talk early on about some really important issues. Here are my top five areas prospective business partners need to discuss and agree on:

The Exit Strategy. It may seem odd to put last things first, but it is hard to have a successful journey together if you haven’t agreed on where you are headed. Solo entrepreneurs need to know their intended exit as well – it will help them make consistent decisions that uniformly move the company toward the intended goal – but for partners it is imperative. Many of the decisions you will make together as you go forward, about raising capital, salaries, employees, loans, expansion, dividends, accounting, capital investment, all will impact the viability of the exit. Know where you’re headed together and you reduce the number of fights over these issues dramatically.

The Governance Model. Agree up front on how hard decisions will be made. Early on, there is likely to be a lot of agreement.  Everyone is excited and getting along. Do not fool yourself – there will be times ahead where you do not all agree. How will you make decisions when you do not all agree.  There are several viable decision-making models – and a good business attorney, business consultant, or mentor can guide you through the choices – but you should agree on a model up front, while everyone is getting along.

Pro Tip: You must make sure your legal governance document (Bylaws and perhaps a Shareholder Management Agreement for a corporation, an Operating Agreement for a limited liability company, a Partnership Agreement for a true partnership) reflect the governance model you have chosen.  Too often attorneys simply draft a boilerplate agreement and the voting and duties provisions in that agreement do not match what the partners are actually doing. This can be a very expensive mistake. Take the time to go through the governance documents, all together, with your attorney, and make him put those provisions in plain English you all understand.

Adding Partners. Will the initial group of partners be the only permitted owners, or do you plan to expand? Can spouses or children become owners? Will key employees be offered ownership? If the answer to any of these questions is ‘yes’, or even ‘maybe’, you must agree now on a fair mechanism to handle these important events. What vote is required? How is the buy-in price determined? How are the votes redistributed (hint: you have to know your governance model before you can answer that question). Once the actual situation comes up, it will be nearly impossible to come up with a fair system, because each partner will have a stake in the outcome of that particular situation.  Better to put a system in place before a real-world decision needs to be made, and then follow the system when the situation arises.

Caution: The decisions whether to allow spouses or children to receive, be transferred or inherit shares and become partners can be a difficult one. Partners who get along with each other may not get along with their partner’s spouse, or be impressed by their partners’ children. These discussions can be emotional and must be handled with care, but that is all the more reason to have them and have them before the issue arises. There are several ways to handle this issue - including allowing spouses or children to receive or inherit non-voting shares that allow them to benefit economically without participating in governing the company, but in those cases, the non-voting partners’ rights to records and information must be carefully spelled out.

Capital. Agreements on capital are more complicated than just agreeing on how much money each partner must put into the business at the start. Small businesses must be flexible, and there are a variety of capital needs that may arise. You must be prepared for all of them. If the company needs more capital, for example, can the partners be forced to put in more money (a ‘capital call’, and what happens if a partner cannot, or will not, meet a capital call? Often, partners meeting a capital call can get extra voting and profit rights over those who fail to meet a capital call. Take care, however – in a partnership where some partners have significantly more personal financial resources than other partners, this can be used to squeeze partners out unfairly.  The mechanism for calling in capital and handling failure to meet capital calls must be carefully crafted based on the makeup of each particular partnership. Capital can also come from third parties – in the form of investors or lenders. These eventualities must be planned for.  If the company decides to raise capital by selling shares, will partners be permitted to buy shares themselves and increase their own voting and profits rights (so-called “preemptive rights”).  If the company decides to raise money by borrowing, must partners agree up front that they will sign a personal guaranty (almost a given in a start-up) and is there a penalty if a partner does not sign a personal guaranty? Work these issues out up front.

Personal Exits. The only constant in this world is change. You may all agree on the exit strategy and you may all be committed to the company at its inception, but your plan must allow for that to change. Someone may want to leave. Maybe they are not happy. Maybe their spouse got a job in another city and they have to move. Maybe they die or become disabled. Maybe they want to retire. Maybe they just want to go teach or join the Peace Corps. Whatever. The more partners you have, the more likely someone wants out, or is forced out, before you expected. A good agreement covers these situations.  Know up front that these are probably the most emotional decisions that your partnership will face. It is critical to have a detailed plan for handling these situations. Is someone who is leaving allowed to sell their shares? To whom? Must they offer the shares to the company or the other partners first? Must they, instead, leave their capital in the business until a certain term expires (common in LLC’s)? If so, how is that to be handled? If the company is to buy back their interest, how is the price determined and how will the company pay for it – insurance? Over time, and on what terms? Will there be a non-compete? Do different exits trigger different terms? If you do not have an answer to these questions, you are likely to find that a Judge will be providing them for you. Expensively.

Bonus Tip: Intellectual Property. Does your partnership have intellectual property? Sure it does.  Trademarks. Copyrights. Patents. Most companies have at least some of these. More importantly, some companies – like tech companies – have copyrights or patents the author or inventor of which is one of the partners.  In this case, it is absolutely essential that the ownership and rights to the intellectual property be spelled out from the beginning. Some of the most titanic struggles I have seen have been between former partners who did not agree, clearly and in writing, up front, who would own the copyright on a software program or the patent on an invention. Decide up front. Get the help of a competent intellectual property attorney to formalize your decision properly. Save yourself a giant headache later.

These are not the only areas where agreement up front can help smooth the path for a potential business partnership. Partner time and duties, growth and expansion plans, partner compensation formulas, employee management issues, record keeping and record access, and competitive advantage are all areas where open and early discussion is merited. If you can discuss and agree on these five, though, you will be far ahead of the bulk of your contemporaries, and on your way to a successful partnership venture.