Are Lawyers Required for Partnership Agreements?

Top personal, tax and business formation issues that drive partnership agreements

Q.  Awhile back, you wrote an article about the need for partnership agreements at the start of any collaborative business venture. I'm going into business with my best friend and want to protect our friendship. Where can I get a partnership agreement? Are some agreements better than others?

A.   Oil and financial baron John D. Rockefeller is credited with saying that "A friendship founded on business is better than a business founded on friendship."

While there are so many instances of friends becoming successful business owners together, Rockefeller's sentiment underscores the practical point that going into business with a friend is a tricky business indeed! Good care is required.

I'd like to say that a partnership agreement can protect your friendship but it can't. This treasured asset can only flourish with good will and commitment.

What a partnership agreement can do is ensure all partners will be treated in a consistent way in good times and bad. The best of agreements lay out in straightforward terms how profits, assets, debts and other responsibilities will be shared while you are in business together and if one of you decides to abandon the entrepreneurial cause.

While it is fun for friends to fantasize about trade logos, new products and first customers, the process of constructing a partnership agreement gives entrepreneurs the discipline to talk through the nitty-gritty details of how decisions will be made, what money can be taken out of the business, how new partners can invest, and what happens if one partner dies or becomes disabled.

So where can you get an agreement? The Kauffman Foundation (www.kauffman.org) offers a good example of a basic, though extensive partnership agreement. Its primary value, I believe, is to familiarize entrepreneurs with a wide range of issues that influence how partnerships are organized and managed. It's a worthwhile read.

There are also a number of online sources that sell what I call "McAgreements." These cookie-cutter documents prompt partners to fill in the blanks covering the basic terms of partnership organization, distribution of profits and losses, and what basic steps will be taken to buy or sell partnership interests.

Because every business is different, I encourage startup entrepreneurs to spend the money to get a customized agreement from a lawyer. If for example, you and your friend plan to open a sports bar together, the partnership agreement would be quite different than an agreement governing two friends writing movie scripts together on weekends.

Another reason to consult professional advisors is to avoid tax surprises. If one partner contributes cash and another contributes assets or intellectual property, then the IRS will pay attention to how non-cash property was valued at the time of partnership organization. Also, there are special tax considerations for selling or transferring an interest in a 50-50 partnership.

I'm frequently asked how entrepreneurs should select legal counsel. First, it's worth it to find a specialist who routinely serves young, growth-oriented companies. Since most business attorneys charge the same rates, you get more value by working with an attorney who understands the nuances of state partnership law. For example, should spouses of partners sign partnership agreements to demonstrate agreement with partnership sale provisions? Possibly. A good lawyer will know if one partner's potential divorce could unravel a partnership based in a community property state.

Second, choose an attorney who is patient and answers questions fully without intimidation or too much legal speak. Good lawyers make good teachers. The more you know, the better your partnership. If the lawyer dismisses your questions, it's time to dismiss your lawyer. Just keep up the pursuit until your partnership agreement is in place!

Take Command Action Step

If you are entering into a partnership with one or more people, ask yourself if each of the partners is equally "sophisticated? Do you have a deeper education about the nuances of legal agreements than your partners? What do they need to learn to get on a more equal educational footing with you? Is there something you know that might later be construed as taking advantage of another partner's inexperience? The best business partnerships I know are based on what I call "operating trust and respect." Once any single partner loses the trust and respect of other partners, the partnership is effectively doomed to resentful failure. Instead, choose the more productive, ethical path. Make sure all partners understand the fine print of partnership agreements at the start of the partnership. You can do it!

Do you need time-saving tips to help fund and grow your business? Ask Susan How! Write to small business funding expert Susan Schreter at susan@takecommand.org