You and your partner are starting a new business. Naturally, you’re excited about what lies ahead for the company. Failure is the furthest thing from your mind. This mindset may motivate you to keep going, but planning for the worst case scenario makes smart business sense.
A business “prenup,” or partnership agreement, can help you do that.
The Importance of Creating a Partnership Agreement
If you plan on going into business with a partner, it’s crucial that you create a partnership agreement. This is one of the most important but overlooked aspects of the business planning process.
A partnership agreement will outline an agreed-upon strategy on how to handle unforeseen events. If you have a disagreement, your partner decides to leave, or your partner dies unexpectedly, what will happen to his or her share in the company? If no agreement is put in place, a spouse may step in to take your partner’s place, or you may lose your business altogether.
It’s best to create a partnership agreement early on when both of you are in the same mindset. Once business operations are underway, personal interests may change, which can lead to disagreements when creating the agreement.
Creating the agreement before the business opens its doors is also a great way to ensure that everyone starts off on the same page and understands the “rules.”
If you value your business partners, you’ll create a partnership agreement.
What’s Included in a Partnership Agreement?
A partnership agreement can be very simple, and include the terms under which a partner would buy the other one out. This is often referred to as a “buy-sell” agreement. No matter what you decide to call it, the agreement should detail what would happen in the event that a partner decides to exit the company.
Ideally, a partnership agreement should be created with the help of an attorney and with specific requirements.
One of the most important aspects of the agreement is share valuation. How will shares be valued if you or your partner decides to leave the business? This is something that you should be considered very carefully, especially in the early stages of the business. The share valuation of each partner should be reviewed every year.
Many small businesses choose to use a multiple of total revenue as a form of valuation. This makes it easy to agree on a fair calculation, but it does not provide you with much flexibility in terms of questionable or subjective amounts.
There is no right or wrong way to determine valuation when creating your partnership agreement. Regardless of which method you choose, clarity is the most important thing. It needs to be precise, so it cannot be questioned. In the best case scenario, you will use a formula that’s easy to understand, or a calculation that all partners agree on.
You and your partners will dedicate a great deal of time and effort to building up your business, so it’s important to take measures to protect your business should you or one of your partners decide to leave. In the event of a divorce, death, or change of interest, a partnership agreement will allow you or another partner to buy out exiting partner’s shares, and continue operations as normal.
The Micklin Law Group, LLC is a New Jersey law firm specializing in family law and estates. Attorney Brad Micklin was recently named to The National Advocates list of Top 100 attorneys from each state. Brad has a special expertise in working with high asset divorce. You can read more on this topic by visiting our prenuptials blog. To set up a consultation, call 973-562-0100.