Without establishing the proper agreements in advance, a failed business partnership can lead to years of costly litigation.

Partnership dispute and business divorce: What you need to know

August 28, 2014 6:25 pm Published by Leave your thoughts

When considering the American dream, being a business owner probably springs to mind. Although some may own a business on their own, many take on business partners. Not unlike a marriage, this is a significant relationship in which people work together to build something.

But what some business owners may not know is that without the necessary legal documents in place, the American dream can turn into a nightmare.

The fact is, a partnership is still a relationship. And like a failed marriage, when two business partners are not on the same page about how the business will operate, what seemed like a potentially great working relationship can turn into business divorce, and when it does, the legalities of the situation are bound to get messy.

When a business partnership fails — differing expectations

Business partners that decide to enter a working relationship bring their skills together, as well their finances, to establish the venture. However, one partner may operate under the assumption that all partners will be working 80 hours per week, while the other partner is a family person with completely different expectations for work-life balance.

Sometimes a partner will invest money into a venture and then sit back, expecting to not have to do any work. Why does this happen? Because they are technically an owner, they may say, "I get my 25 percent draw against income because I am an owner. I don't have to work."

Yet someone has to do the work, and this type of relationship ends up breeding resentment that leads to nuclear fallout and ends in business divorce. It may technically be business, but that doesn't mean things won't get personal. There are many ways a business partnership can fail, but the fallout doesn't have to be catastrophic. Writing up an operating document in advance can help reduce the damage.

It is not uncommon for business partners to split up. Defining the terms of the agreement in advance will save you the trouble of the conflict that may come later.

What's in a business partnership agreement?

The operating agreement established between partners outlines what percentage of the company each person owns. In addition, there is an outline of what each must contribute in order to own that percentage. This may include aspects of the business such as money, equipment and work performed.

But the agreement goes further than that. It should outline a detailed description of "sweat equity." The agreement should outline in detail, the following aspects of the business:

1. Job description of the equity partner. This part of the agreement is to outline the job description of the sweat equity partner including their duties and milestones. It should include a statement outlining whether ownership vests immediately and is paid for by work, or whether it is earned and is thus vested over time.

2. Type of management. The type of management must be defined in the agreement. What are the limitations on authority? Will it be members or manager, unanimous consent or ordinary course of business?

3. Buy-sell agreement. The buy-sell agreement outlines the price and terms that would apply in the event of a partnership buy-out. This agreement is essentially a business "prenuptial."

What happens without a buy-sell agreement?

Failing to draw up this agreement during the initial stages of your business could mean you end up in a business "divorce" if you and your business partner decide to split up. This means you will have to negotiate, probably hire a lawyer and enter many months of costly litigation. In fact, business divorce can be one of the most costly and time consuming types of litigation.

Without these documents, you could end up arguing over the business for years. In some cases there is a hostile takeover of the company and one partner gets locked out. This is the type of situation where you will want the help of a firm that can draft a demand letter from hell to get the other party to bring a lawyer on board for negotiation.

A detailed operating agreement can help you bypass this potentially messy and expensive experience.

Choose your business partners wisely

Like any relationship, the partner you choose will affect its success. Money is not the only consideration—agreeing on a common vision and being compatible are just as important. It's worth noting that hard work might not be enough to generate a livable income off of your business, but you should expect to work hard in any case, unless you are a passive investor and it has been documented.

Treat this relationship like it is just as important as any of the others in your life. Meet with an attorney to set up the proper organizational situation for your business, such as a corporation, Sub S or LLC and be sure to draw up an Operating Agreement as well as a Buy-Sell Agreement. Consider additional factors like what will happen in the event of death, divorce or departure on the business.

Adding alternative dispute resolution to the agreement will help you avoid the risks of litigation in the event of a business split. Treating your business partnership as a relationship from the beginning will help you run it smoothly in any situation.

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