Essential Exit Strategies for Every Partnership Agreement

Essential Exit Strategies for Every Partnership Agreement

July 26th, 2010 | by admin |

Copyright (c) 2010 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. Not by choice. Occurrences such as death, divorce and disability affect the company. In the even of a death or divorce of a business owner, the person’s spouse could well end up as co-owner, expecting the benefits paid out to the previous owner. Physical disability or mental incompetence could have a more disastrous financial impact on the firm. How long can a business support the salary and profit sharing of a partner who is unable to contribute to the company? Avoid this potential drain by setting in place the necessary provisions and insurance policies for disability.

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.Exits by Force (expulsion). Sometimes, you face the unpleasant situation of needing to kick out an owner. Perhaps “he” was caught with a hand in the company till. Maybe “she: refused to contribute more money to help the company. Perhaps one of them has repeatedly been sexually harassing employees. If you reach the point where, for grave reasons (not just “we don’t get along”), you need to give an owner the boot, the agreement should spell out those situations.

4.Differences. Not seeing eye-to-eye is common in all business enterprises. However, sometimes the split runs too deeply for reconciliation. How does a business partnership break a deadlock without going into costly litigation? Building dispute resolution procedures into an agreement between business partners avoids the disaster of having to dissolve the business.

5.Determining A Firm’s Value. Establishing fair value for a firm in the event of a buyout is key to an intelligent exit strategy. It enhances value for the departing partner, reduces the risk of conflict, prevents disruption to the business and ensures its continued smooth running. With this crucial ingredient in place, stakeholders can focus on growth and prosperity with the assurance that they will be fairly treated in a buyout.

Designing an effective partnership agreement requires a great deal of planning and an ability to forecast or anticipate different likely scenarios. It should be about leaving a business on terms mutually agreed on at the start of the business when all partners are willing to work together. If you are in doubt how to proceed, consult an experienced business attorney who will plan an exit strategy to maximize value to you and your partners.

Fed up with the convoluted legal issues your small business faces? Check out the resources from Nina Kaufman, Esq. at http://www.GreatBusinessLawResources.com . She demystifies legal mumbo-jumbo to save you time, money, and aggravation. She’s also an award-winning business attorney, speaker, and columnist/blogger for Entrepreneur Magazine online. Get a free copy of her Entrepreneurs Business Law Primer at http://bit.ly/freebizlaw