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Setting up a partnership is a common way of starting a business for many reasons. For one, it’s easy to establish. It entails a more personal approach to doing business and is usually built on trust. It’s also easier to raise more funds by bringing in more partners. Creating a business partnership, however, should not be an impulsive decision. There are important details you need to take into account to succeed in a business partnership.
1. It’s a must to properly establish profit and loss sharing.
One of the most important things to bear in mind is to learn how to split profit properly in a partnership. It is one of the first steps that should be undertaken. This is to make sure that there will be no profit-related issues that will be encountered later on. Profits cannot always be divided equally especially when the capital contributions of partners change. Also, there are instances when industrial partners (partners who contribute services instead of capital) are involved so it’s important to have a clear agreement on how much these partners are going to get.
There are no laws that dictate how partnerships should divide profits. Profit division generally relies on what the partners agree. As such, it’s very important to put everything in writing. Profit division can be based on capital contributions as well as on the roles the partners play in running the business. There may be other considerations that need to be taken into account such as the goodwill or intangible assets a partner brings into the business. All these details should be clearly indicated in the written agreement for the partnership.
In case losses are incurred, the loss sharing scheme should also be agreed upon. This agreement depends on whether a partnership is a general or limited partnership.
2. The functions, responsibilities, and rights of partners should be clearly stated.
In addition to the profit sharing scheme, it is likewise important to put in writing the details of what each partner is expected to do in the partnership. The rights and responsibilities of every partner, including the industrial partners, should be unequivocally laid out. Additionally, corresponding penalties or sanctions should be established and put in writing in case partners fail to perform their responsibilities. Partnerships are largely built on trust but there should be no presumption that everyone will just do their designated functions as expected.
3. It is also necessary to establish roles for signing and authorisation.
All partners are considered co-owners of a partnership business. However, this does not automatically mean that everyone should be involved in signing official documents and authorising actions or decisions. Following such a setup would be highly inefficient and impractical especially if there are numerous partners involved.
It would be advisable to designate partners who would represent the partnership in external affairs. However, these designated managing partners are not supposed to be given absolute authority. Limits should be clearly set.
Additionally, it is important to determine the number of votes for certain decisions. For example, a partnership may agree to require a unanimous vote to accept a new partner, ⅔ of all partner votes should be needed to expel a partner, or simply a majority may be required to decide on matters discussed in meetings. Obviously, more important decisions are to be given greater weight hence they shouldn’t be decided by simple majority.
4. It’s important to have a buy-sell agreement.
A buy-sell agreement is an arrangement wherein partners are given the option to buy the percentage ownership or share of a partner who intends to leave the partnership. This is necessary for the protection of the partnership. Partners cannot unilaterally decide to leave the partnership and sell their shares to a third party. It’s important to decide if the other partners should buy the share or return a leaving partner’s capital contribution.
This buy-sell agreement should extend to the family members of all partners. In the case of death or severe illness, the family of a deceased/sick partner will obviously inherit the share. This does not mean they can just do whatever they want with the inherited share. It’s important to come up with a consensus whether other partners should be allowed to buy the share or to return or turn over the capital contribution of the deceased/ill partner.
5. New partner acceptance and partner expulsion should be agreed upon.
A partnership cannot simply allow anyone to join the partnership. There has to be a process and requirements. All of these need to be clarified upon the establishment of the partnership. Similarly, in case a partner has to be expelled, the policy should already be set in place upon the founding of the partnership. These matters cannot be arbitrarily decided upon.
It is necessary to unambiguously state the reasons for expulsion. A handful of partners cannot suddenly decide to expel someone for some reason they come up with. Right from the start, all partners should be made aware what can possibly get them expelled from the partnership.
6. A non-compete agreement should be set up.
A non-compete agreement is basically a legally binding understanding among partners that prevents the partners, in case they leave the partnership, from opening a business that directly or indirectly (depending on the agreement) competes with the business of the partnership. This agreement should have a specified period of time. It could be for a year, two, or more. The goal of this agreement is to prevent a leaving partner from threatening the business of the partnership using the knowledge, resources, or intangibles obtained from the partnership.
7. There has to be dissolution or exit plan.
Lastly, all partners should have a plan or mechanism for addressing dissolution. Events or conditions that can lead to the dissolution of the partnership should be determined. This is necessary especially in general partnerships since there are instances when a business is already losing a lot of money and many partners still don’t want to give up, and other partners are tied to an agreement that they cannot simply leave. It’s important to list down in detail the possible scenarios that should compel the dissolution of the partnership.
Ultimately, all of these boil down to one thing: agreement. Again, partnerships are built upon trust. Partners will have to agree on a lot of things vital to the operation of the partnership. Everything should be clearly established and put in writing for the protection of everyone in the partnership and to have an organised way of handling the affairs of the partnership.