4 key elements of a solid partnership agreement

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Setting up a business partnership is a little like starting a romantic relationship, even though the benefits and perks are different. When love -- or a great small business idea -- is in the air, it's easy only to focus on the positives.

A solid partnership agreement also takes into account a number of "what if?" questions, especially negative outcomes you might prefer to ignore in all the excitement. If the worst does happen, your partnership agreement should protect both you and your partner.

Here are the basic questions every good partnership agreement should answer:

"What if one partner wants to leave?" Exit clauses are standard in partnership agreements. For example, if you want out, your partner may be obligated to purchase your ownership share.

That's the easy part. The tricky part is determining the value of the business when that happens. Business valuation is part science, part art, and different approaches often generate very different results. Whether you agree to use liquidation value; book value; or the income, asset or market approaches, stipulate in your partnership agreement how the business will be valued and whether a third party will conduct the valuation. Then the breakup will be a lot cleaner and less emotional.

"What if one partner dies?" Say your partner passes away. Typically her ownership stake passes to her spouse or children. You automatically get new partners -- new partners you may not want. A buy-sell agreement can allow you to purchase your deceased partner's share, but what if you don't have the money or can't get financing?

There's an easy solution: Stipulate that each partner will carry life insurance sufficient to cover the purchase of the other partner's share. Each partner designates the other partner as beneficiary. Then, if your partner passes away you always have the funds to complete the buy-sell agreement. Just make sure you add additional coverage as the value of your business grows.

"What if one partner wants to change the agreement?" Perspectives change as a business evolves, and partnership agreements can be amended as often as you like as long as all partners agree.

Sometimes one of you might not agree to proposed changes, so stipulate how fundamental disagreements will be resolved: Mediation, arbitration, triggering a buy-sell clause and more. Knowing how a problem will eventually be resolved if you aren't able to agree often makes it easier to work through differences.

"What if we don't agree on major issues?" No matter how well you work together now, misunderstandings, hurt feelings and changing priorities can damage the best relationships. When that happens, falling back on the terms of your partnership agreement can help both of you stay objective.

For example, your partnership agreement may stipulate you are responsible for 60% of the work since your partner provided a greater share of initial capital. If he feels you aren't doing your share, the more clearly you defined what "the work" means in your agreement, the easier it is to determine whether you are in fact pulling your weight. Whenever possible, use hours, numbers, dollars -- quantifiable measurements.

"What if we've already started a business with a partnership agreement?" If the agreement you have is insufficient, it's not too late. (And if you have no agreement at all in place, it's definitely not too late.)

Simply amend your current agreement or create a new partnership agreement. If you feel changes are necessary and your partner does not, explain that your only goal is to eliminate as many potential disagreements as you possibly can.

  • Jeff Haden On Twitter»

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    Jeff Haden learned much of what he knows about business from managing a 250-employee book manufacturing plant. Everything else he picked up from ghostwriting books for some of the smartest CEOs and leaders in business. He has written more than 30 non-fiction books, including four Business and Investing titles that reached #1 on Amazon's bestseller list. Follow him on Twitter at @Jeff_Haden.

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