Exit Strategies Vital to Partnership Agreements



Posted: Tuesday, January 26, 2010

by Nina Kaufman
Ask The Business Lawyer

IRS figures show that millions of people go into business with at least one other person in a partnership. However more than two out three fail to survive, according to AssociatedContent.com. This is where the partnership agreement plays an important role. They are also known as shareholders agreements or operating agreements for a corporation and LLC respectively. Within the scope of the agreement, you and your partners can decide beforehand what is deemed equitable and fair in the event of a split, in what is known as an "exit strategy". While exit strategies play a role in all types of businesses, certain issues crop up more frequently when two or more come together to form a business.

Here's a cautionary tale that can happen if you haven't worked out exit strategies with your business partners: Gregory and Kristov were boyhood friends who started a men's clothing line together. They formed a corporation and signed a shareholder's agreement under which Gregory was obligated to put in the money and Kristov promised to put in the marketing and clothing design ideas. One year in, and Kristov was spending the money on fancy parties and supermodels faster than Gregory could make it, so Gregory wanted to call a "time out" to re-assess how the money was being spent. Kristov was incensed. After all, marketing was his job and Gregory was supposed to fund his work. Gregory was incensed. After all, money didn't grow on trees and there had to be some fair way to stop the bleeding. Their shareholder's agreement had no provisions on how to resolve basic disputes between the business owners and no provisions on how to handle a buyout of the company if they reached a deadlock. As a result, the company went through expensive litigation to dissolve and liquidate the business . . . which effectively destroyed the company and the friendship between the two.

How can you avoid this horror story? By establishing (1) reasons behind an owner's desire to leave the business, and (2) how much represents a fair price for his/her stake in the firm on departure. There are myriad reasons why someone wants to leave a company; here are some of the more important ones.

1. Unplanned exit from death, divorce or disability of a partner. Have the partners agreed on how to handle succession? What happens if the heirs or angry spouse demands becomes a co-owner and demands all the rights due to the previous partner? A disabled or mentally incompetent partner can be a severe strain on the firm unless provisions and funding for disability insurance are established to cover such an event.

2.Exits by choice. These include resignation and retirement. An owner may want to leave the business voluntarily. Perhaps the business is not generating enough money for them to meet their needs. Or, they are facing a lifestyle change, such as having caretaking responsibilities for a chronically ill parent or new baby. Or, perhaps they have an opportunity to fulfill a lifelong dream of working with the Peace Corps. Or, they want to retire. The partnership agreement should include a procedure for purchasing the resigning partner's interest.

3. Giving the Boot. If a partner is found stealing from the company or sexually harassing the staff, those should be grounds for expulsion. Perhaps he or she is shirking from responsibilities -- the partnership agreement should clarify the grounds for giving someone the boot.

4.Irreconcilable Points of View. Partners change their views on how to run a firm and while most can work through their differences, sometimes, the split in opinions runs too deeply. Are there provisions for working through disputes amicably? If there are no provisions in the partnership agreement to settle a deadlock, the only option is business dissolution.

5. Business Valuation. Valuing the worth of a business is one of the most crucial items in a partnership agreement. In the event of a buyout, how do the partners determine the worth of a firm? Are they getting a fair value for their share? The manner of business valuation should be spelled out at the beginning of the business so that everyone can concentrate on developing the company, with the assurance that he or she will get a fair price in the case of a buyout.

Partnership agreements lay the groundwork to cover all possible contingencies, including the worst, such as expelling a partner. It is best to address such issues at the beginning of a partnership when everyone is on good terms with each other, and there is not a whole lot at stake to fight over. Get maximum protection for the rights of all partners by working with an attorney who understands and has extensive experience in partnership agreements for small business.

Copyright (c) 2010 Ask The Business Lawyer

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Fed up with the crazy legal issues your small business faces? Check out the user-friendly business law resources from Nina Kaufman, Esq., at http://www.GreatBusinessLawResources.com . She cuts through the legal gibberish to save you time, money, and aggravation. She also writes and blogs for Entrepreneur Magazine online. Get a free copy of her Entrepreneurs Business Law Primer at http://bit.ly/freebizlaw
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