The Partnership Dilemma: What Happens If You Break Up?

Last Updated Apr 21, 2011 8:50 AM EDT

A reader asks:
A friend and I are starting a business together and we're in the process of creating our partnership agreement. We're working from a partnership agreement template and have worked out things like responsibilities, investment, how decisions are made, and how profits are shared. I feel sure we're missing something -- any advice?
Setting up a business partnership is a little like starting a romantic relationship (although the benefits package and perks are different.) It's easy to only focus on the positives. A solid partnership agreement also takes into account a number of "What if?" questions, especially potentially negative outcomes you might not think about in all the excitement. If the worst does happen, your partnership agreement should protect both you and your partner -- just like a prenuptial agreement.

Here are some of the major considerations:

"What if one of us wants out?" 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 result in 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 of us 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 of us wants to change the agreement?" In his new book, Paul Allen claims Bill Gates asked Allen to change their ownership split of Microsoft several times. 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, etc. 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 can't get along anymore?" 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're already in business?" If the agreement you have is insufficient -- or if you don't have a written agreement -- it's not too late.

Take a step back and create a comprehensive partnership agreement. If your partner hesitates, explain you aren't trying to change your current working conditions. All you're trying to do is eliminate as many ways you might disagree in the future as possible.

Fortunately, talking about potential negatives with a potential business partner is a lot easier than having that discussion with a romantic partner. Asking "What if we break up?" may not be the greatest way to start a relationship, but it's the perfect way to start a healthy business partnership.

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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.