If you are considering entering into a partnership, or are already in one, there are critical issues to address if you want to succeed.
Recently on an episode of our “Refresh Your Wealth” Radio Show and Podcast, we compiled our Top 10 Dos and Don’ts to ensure success in a business partnership. The time to consider this is now. The wrong time is after a problem has occurred in the relationship. Here is a list of items to talk about with your partner over a Grand Slam at Denny’s this weekend:
- Have a Written Partnership Agreement. Do have your agreement in writing? Are you simply relying on memory or on that napkin from Dennys? Everything always seems clear and positive while you are shaking hands across the table and the sky’s the limit. It’s vital that you put the agreement in writing from the start and continue to memorialize changes to the business as you proceed. Whether it’s a good thing like splitting profit, or a problem of needing more cash, everyone’s memory ends up being different and even a little hazy.
- Have a provision for ending the relationship or an exit strategy for the business. Don’t assume your partnership will never end or you and your partner will have the same vision as to when it does end. All good (and bad) things must come to an end, and yes, that includes your partnership. If you don’t prepare for this eventuality, it may come back to haunt you. Make a plan for how partners may leave, including how they will be compensated for their share of the partnership. This way you are not forced to end operations when one partner decides to move on, taking their investment, and possibly your clients, with them. This can include a buyout over several weeks, months, or years; and a non-compete agreement that restricts the exiting partner from taking the partnership’s clients.
- Have an attorney review your agreement. This can be a costly mistake and far more expensive than paying a few hundred dollars up front at a minimum. Keep in mind your partner, or their attorney, may not have your best interest in mind and looking out for you. Your partner’s attorney was hired to look out for your partner’s interests, not yours. Attorneys generally only see partnership agreements at two stages, when they are created, and after they go horribly wrong. Using an attorney’s experience and knowledge to review your agreement from the beginning will save you a lot of heartache and money when something goes wrong. Do your due diligence on your partner; don’t rely on their word alone. Trust, but verify. None of us would enter into a partnership agreement with someone we didn’t trust, but just because you trust your partner, doesn’t mean you shouldn’t verify any representations they make to you. Trust is best earned through repeated verification.
- Go slow and be cautiously optimistic. Don’t rush into a partnership. Be careful if your partner is putting a lot of pressure on you to move quickly, especially if you are putting in cash. Generally, people don’t make good decisions under pressure and we need time to digest the agreement and plan. With that said, be professional, not emotional, and don’t drag your feet intentionally. However, make sure it feels good in your gut and makes sense in your mind. Both of those two factors are critical when considering a partnership relationship and before signing the bottom line.
- Document a detailed list of duties and compensation for work partners. Some partners are contributing services or labor, rather than putting dollars on the table. That’s ok. There is nothing wrong with that. But delineating the duties of the working partner will help the partnership in many ways. Obviously, with this list, both partners will know what is expected of the working partner and you can avoid letting items fall through the cracks and costing the partnership money. Also, this list will help the partners determine what additional compensation, if any, is appropriate.
- Have a specific agreement and terms for the cash partners. Just as important as the duties of service partners, are the expectations of the cash partners. Is it a capital contribution or a loan to the business? Are there going to be interest payments? Or will they receive extra distributions? When the business is sold or operations terminated? Do they get their contribution back first before profits are distributed or only upon the sale of the business or its assets? There isn’t a wrong or right answer to these questions, except that they have to be discussed and decided upon.
- Determine responsibilities, and authority of each partner. Even if both partners are cash partners, or you have already defined a service partner’s duties, it’s important to grant each partner authority and assignments for certain aspects of the business. Consider items such as marketing, web design, and hiring, also other items like finances, bookkeeping, taxes, and forecasting. If everyone is trying to do everything, the partnership won’t be very efficient and something is likely to fall through the cracks (like paying the power bill), and no one will know until it is too late (after the lights turn off). Find out what each partner does best and let them do it, with appropriate oversight, checks, and balances.
- Consider the issue of joint and several liabilities. Did you know that your partner’s actions are your actions? If your partner does something in your business to create liability, even a day after you shake hands on the project, you will most likely be personally liable even if you weren’t present. This is why having a proper legal structure for the partnership is critical. A joint venture agreement or partnership agreement is good…but not great. If you don’t at least have an LLC or Corporation, you could end up being personally liable for a lot more than simply your investment.
- Have a plan for reinvestment. How much of the profits do you plan to reinvest back into the business? Your opinion or understanding could be very different than that of your partner. Make sure you are on the same page when understanding that reinvesting is key to the growth of any business, but it also needs to be pragmatic based on the success and future of the business. Don’t expect that you and your partner will always be on the same page as to the vision of the business.
- Don’t forget distributions in order to pay taxes. Remember, with flow-thru entities you may have a profit on payer, but all of your money has been reinvested into equipment or inventory. If that’s the case, you’ll end up with what is called ‘phantom income’. Profit on paper and no cash. Thus, if you don’t take enough distributions to cover taxes, you will end up with an unexpected tax bill with no cash to pay Uncle Sam. Include a provision for minimum annual distributions of at least 25% of the profit. This could ease the bulk of any tax burden for the partners.
Partnerships are an amazing thing. So many businesses succeed because they are a partnership. However, if not properly structured and maintained, with lots of communication, they can destroy a business. Take these 10 items above to heart and have a meaningful conversation for each, while putting it all in writing!
[Written in collaboration with Deven Munns, Attorney at KKOS Lawyers]
* To sign up for Mark’s weekly Free E-Newsletter and receive his Free E-Book “The Top 10 Best Tax Saving Secrets Everyone Should Know” visit www.markjkohler.com.
Mark J. Kohler is a CPA, Attorney, co-host of the Radio Show “Refresh Your Wealth” and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street isn’t Telling You” and, “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP.