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This article was originally written and published in The Business Bulletin.

Some time ago our little group of writers was requested to write an article on this topic. The reader noted that sometimes it was more desirable and practical to do business with someone else than by themselves. Yet many people find themselves with a sour taste in their mouth after the partnership is dissolved (not to mention beforehand). It doesn’t have to be that way.

For purposes of simplicity, in this article I will use the word Partnership in reference to a business owned by more than one person, whether in reality it is a Partnership, Limited Liability Company, or Corporation. Disclaimer: if you are my client and are reading this, please know that this article is not talking about you, but rather it is a collection of the many experiences I’ve had working with people in partnerships over the past 25+ years in this business.

My Grandpa used to say that a good preacher would tell the people what he was going to say, then say it, then tell him what he just said. So up front I will break my little dialogue down into sections like this:

• “Good Fences Make Good Neighbors!”

• Loaning to vs Investing Money in the company: Why they are different.

• Ownership and Compensation are two different things; both must be addressed

• We believe that marriage is for life, but partnerships almost never are.

• Partners that separate can remain friends.

So what do fences have to do with partnerships?

Be truthful, when you buy a piece of real estate, you are very interested to see where the little stakes with red tape are, aren’t you? If both of you know there is a good fence there in the right place, you don’t have to worry about the boundary anymore, do you? Yet many people go into a partnership with no boundary stakes (formal written agreement). They say, “We’re brethren and we trust each other. Neither one of us would take advantage of the other.” They are afraid to insult the other’s integrity and I can understand that. Yet, if you think it over, I think you will agree that if you value your relationship with your brother, you will be willing to do some preventive maintenance, and mark the boundary lines. After all, you’re going to have to learn to communicate if you’re going to do business together, trust me!

Sitting down and verbally going over who owns what, who pays for what, and gets paid for doing what, and then actually writing it down forces you to think about those things. It also forces you to come to an agreement on those important points. And whose memory is perfect? If you both have a document to refer back to, it will be clear, like a survey with clear boundary stakes.

When a business starts there is generally some seed money to get it going. If both partners have say $5000 each to put into the account and they are going to be each 50% owners, it makes a very simple. If that is considered their investment, that money does not come out of the company until they dissolve the company, sell their share, or both decide to withdraw it.

Using the same partners with $5000 each as a different example, let’s say they can’t afford to leave it in the company so they put the money with an understanding that the company will pay back within a certain amount of time. This is a loan. Just because they put $5000 each in, does not mean they are each 50% owners, since they are neither one investing capital into the company. Therefore it is not unequal for one partner to loan 50,000 and the other partner to loan 10,000 if they agree to do so.

Loans do not define ownership percentages. Now let’s suppose that partner A has $10,000 to put in and partner B has no money to put in, and yet they both want to be 50% owners. Not a problem. If the partners are agreed that the initial investment should be $5000 each, then partner B gives partner A a promissory note agreeing to pay him back the uneven $5000. Or let’s suppose that partner A has $10,000 to put in and partner B has no money to put in, but partner B expects to have money in the future. Again, not a problem. Partner B gives the company a promissory note, promising to pay the $10,000 in the future to even out the investment. Investment in the company usually defines ownership percentages. Now we have the partnership started with both partners equally invested and equally 50% owners.

Just because there are each 50% owners, doesn’t mean they should be compensated at 50% each. It should be decided who will get compensated for work they do in the company and how much. Then, if there is profit left over, the profit is divided using the ownership percentages.

For example, let’s say two brothers start a trucking company. One brother has a part-time farm and sometimes cannot run the truck. The other brother drives full-time. A good way to handle that might be to pay a percentage of the gross that the truck makes, a common practice in the trucking industry. In this manner the partners are rewarded for the work they do, and if there are profits above that, those profits are returns on investment and are split according to ownership percentages.

Till death do us part? Hardly. So many times, though, when one partner approaches the other about “getting out,” there’s offense or hurt. We don’t enjoy making wills before we die and we don’t enjoy talking about how to separate before we even start together. But for one reason or the other, be it retirement, marriage, going to the mission, or just plain tired of doing the same old thing, one partner will want out. You just as well face in the beginning, get it on paper, and rest it.

The simple solution, and probably the most appropriate for most partnerships is this: sit down and value the partnership when you’re going into it. What does the partnership have for assets and how much are they worth? This would include Cash, Accounts Receivable, Inventory, Equipment and Real Estate. If you want to place a value on goodwill, then you better have a good understanding between each other on how that value is reached. Next you simply add up the debts and subtract those from the assets. The difference between those two (Assets minus Liabilities) is the value of the company. Your method of valuing the company should be the same when one partner wants out. Now just because we know how much the company is worth doesn’t mean we are ready to settle peacefully and happily yet. But at least you don’t have to fight over the value.

It should be addressed at the beginning of the partnership how this separation will take place. The following is an example, “any partner wishing to leave the partnership must give the other partner(s) 60 days’ notice. Within 30 days, the partners shall value the partnership. If an agreement is not reached, a third party (deacons, appraiser, etc.) shall be consulted to assist them in valuing the partnership. The remaining partners shall be given the opportunity to purchase the shares for 95% of fair market value (FMV). If the remaining partners are not able to secure cash to purchase the shares within 60 day period, they will be given the option to give a promissory note to the selling partner payable monthly over 5 years, the purchase price being 100% of FMV. If the remaining partner(s) cannot or choose not to buy the shares of the leaving partner, a third party shall be consulted to assist them in dissolving the partnership in some other way or allowing an outside individual to buy the shares.”

If these issues are discussed up front, much of the hurt can be avoided later. Sometimes it may still take a good dose of charity for one partner not to feel “left out” or “deserted.” But again, it is not “till death do us part!” The partnership is for a time and sometimes people need to move on. Give each other that liberty, and set it up for success ahead of time.

Essential points to cover in your written agreement:

  • Who invests how much money/equipment? Refer to Loaning versus Investing above.

  • What are the partnership ownership percentages?

  • How and how much will the partners be compensated for their work?

  • How and when will profits (above partner’s compensation) be paid out between the partners?

  • Who will keep the books? How will the other partners have access to said books?

  • Are any partners expected to furnish their own vehicles or cover business expenses and not be reimbursed for them?

  • What if someone wants out of the partnership?

  • How do we value his share? (outside appraisal, help from deacons, etc.)

  • How much time do we have to establish a value and buy him out?

  • Who can buy the leaving partner’s interest?

  • Can a deceased partner’s heirs/spouse be partners in his stead?

These partnership agreements do not have to be complicated. It does not have to be a legal document drawn up by an attorney. However, you may wish to have your accountant, attorney, or other advisor read yours and make comment. By agreement of the partners, the document can be amended.

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