Entering into Business with a Friend

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Dear M & M:

I am entering into business with a friend. Someone mentioned I should enter a partnership agreement with them. We are friends.  I see no need to enter into a contractual agreement.

–Jack

Dear Jack:

What a partnership agreement can do is ensure all partners will be treated in a consistent way in straightforward terms how profits, assets, debts and other responsibilities will be shared while you are in business together and what to do if one of you leaves the business. While it is fun for friends to fantasize about new products, opening a store and first customers, the process of constructing a partnership agreement gives entrepreneurs the discipline to talk through the 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. Just like every personal relationship has its ups and downs, so do business partnerships. So before you start your business, you need to enter into what is known as a partnership agreement to protect yourself and your business. Here are some of the common elements that you should include in a partnership agreement, which by the way, must be in writing and signed by all partners. This is not meant to be an all-inclusive list, so consult with your professional advisor.

* Percentage of Ownership. You should have a record of how much each partner is contributing to the partnership prior to its opening. (People have short memories.) Typically, these contributions are used as the basis for the ownership percentage, but this is not a cut and dry formula. For example, one partner may put in a considerable amount of cash, with no plans to work in the business, and a second partner may not invest cash, but will provide the sweat equity to make the business a success. As such, the partner who works the business full-time may get a larger percentage or vice versa. That’s up to you.

* Allocation of Profits and Losses. You must decide if the profits and losses will be allocated in proportion to a partner’s ownership interest, which is the way it is handled unless otherwise indicated. Also, will partners be permitted to take draws? (A draw is an allocation of profits from the business prior to the actual distribution among all partners.) Because money is the root of all evil, as they say, you and your partner(s) need to make these decisions in advance.

* Who Can Bind the Partnership? Generally speaking, any partner can bind the partnership without consent from the others partners. Imagine if your partner, without your knowledge, signed a contract for a private jet timeshare. (Sounds cool, but not practical.) That’s certainly something most small businesses can’t afford and such a liability could be a significant risk to the financial stability of your business. So you must clarify what type of consent a partner must obtain before he/she can obligate your company.

* Making Decisions. Making decisions in a business is often like trying to make decisions in a committee- nothing gets done. In fact, it can often come to a company stalemate and result in business failure. Therefore, you need to establish a decision-making process in advance so your business operations can move along smoothly.

* The Death of a Partner. What happens if one partner is deceased or wants to leave the partnership? To manage these situations, you need a buy/sell agreement. This establishes a method by which the partnership interest can be valued and the interest purchased either by the partnership or individual partners.

* Resolving Disputes. What happens if you and your partners reach a point where you can’t agree? Do you head to court? Well, only if you want to spend a lot of time and money. My recommendation is to include a mediation clause in your partnership agreement to provide a procedure by which you can resolve major conflicts. -SBA

 -M&M

To ask your questions: Call the Small Business Development Center(SBDC) at Cochise College (520)-515-5478 or email schmittm@cochise.edu or contact the Sierra Vista Economic Development Foundation(EDF) at 520-458-6948 or email  hollism@svedf.org

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