Q: What’s the only ship that is sure to sink?
A: A partner-ship
Well, not necessarily, but at least once several times a month, a new client will come into my office asking me to help them “unload” a bad partner. So, I am often asked, “Am I the only one to go through this?” “What could I have done differently?” In the archives of the G&G blog, we have many articles on breach of fiduciary duty and Buy/Sell Agreements but, here are my thoughts on forming partnerships. (These thoughts do not apply to partnerships between husbands and wives. That category of partnerships merits a separate post).
Due Diligence. Even if you have known the potential partner for a long time, business relationships are different. If you have an entrepreneurial mindset, you need to ask and with your own independent judgment, figure out if your potential partner is ready to: (1) Understand that owners get paid last and that division of labor is never fair; (2) Understand that employee friendships can be human resource minefields and should be avoided; (3) Understand that as an owner everything is your business and responsibility and most importantly – (4) a rainy day fund is required and may become necessary. These four categories have one over-arching theme: Does the prospective partner have good judgment?
Partnership/Entity Formalities. If after you have done your due diligence and you still want to go into business with this individual remember that in California, general partnerships do not require a written agreement but it is highly recommended that you get one in place because without a written partnership agreement: 1) the percentage of ownership; 2) the amount of work required by each partner; and 3) the capital contributions are some of the most important details that will be disputed if the partnership is based on an oral agreement. Although I refer to the term “partnership” I note that clients use this term even if they have formed California limited liability companies or corporations. (General partnerships are seldom formed any more except for some tax planning strategies with subsidiaries and very small businesses).
What about that great package of forms from Legal Zoom that you purchased? Doesn’t that protect you from these legal issues? No. It does not. Even if you have a properly formed corporation and you are going to be “partners” with someone in a corporation, you should still agree to the terms of employment with an employment agreement and Buy/Sell Agreement (including triggering terms for leaving the business and buyout pricing). If you know going into the partnership that one of your partners is a great sales person, but that her marriage is on the outs, you need to run and not walk to your business attorney’s office to get a Buy/Sell Agreement put in place to protect your company because even if your marriage is solid you may still be involved in your partner’s divorce from a legal standpoint.
Are There Warning Signs I Can Watch Out For In Selecting A Partner?, Yes. Throughout the last 20 years, I have seen some egregious examples of partnerships gone bad, but a lot of these situations could have been avoided with doing a background check or really identifying what value each partner brings. We cannot plan for every situation, but by planning for the worst, with employment agreements, and Buy/Sell Agreements, the future of your hard-earned investment is much more secure and less sinkable.