What are the important terms of a partnership or shareholders agreement?
It is often said that partnerships can make or break a business. Our experience is that partnerships often fail for the same reason that any other relationship fails:
- lack of communication; and
- misunderstanding as to expectations.
If you can’t meet someone’s expectation, there is going to be a problem. It communication to understand expectations.
Partnership agreements entered into before entering into a partnership help greatly to ensure communication occurs on all the relevant factors and that the expectations of each partner are understood and agreed. Where the partners are commencing a business in a company structure, a shareholders agreement will achieve the same result – such agreement is structured around the intricacies of a company structure. Some of the relevant issues for the business in preparing such an agreement follow.
Objectives and Goals
The objectives and goals of the partnership are crucial. If there is any misunderstanding of where the business is going, the partnership is bound to be affected. It is not the place of the partnership agreement to repeat the business plan, however, particularly if there is no business plan, the agreement should specify the vision of the partners and their fundamental goals. It can happen that a partnership will end here if the partners cannot agree. It is unusual for partners to have disagreements on this point as it is often the shared vision and goals that have allowed them to get as far as the lawyer’s office. However, I have had an instance in which clients of mine have had to seriously negotiate this point.
Shares
The partners need to clearly set out what share each partner has in the business. The proportions should be set out clearly. It may be 50% each. Similarly, the proportion of each partner’s contribution to capital injection for working capital and distribution of profits must be established. Often, they are in the same proportions. The proportion and timing of the distribution of profits also needs to be considered. This was particularly important to some clients of mine recently because it was expected that profits would need to be retained for the growth of the business. Therefore, only 10% of profits were distributed to the partners.
Roles and Responsibiltiies
Partners come together often relying on each partner to bring certain skills, attributes or other benefits to the partnership. These may range from technical ability or marketing skills to financial contributions. These need to be specified clearly in the agreement. This is very similar to preparing a job description for an employee.
Decision Making
The method of making decisions can vary greatly. It needs to be determined how decisions are made within the partnership. It is often agreed that the partners will meet once per month to make the decisions concerning the strategic direction of the business and other non day to day type decision making. It is possible for an agreement to specify that a partner can nominate another party to attend such meetings in their place. Also, it is not unusual for voting rights of each partner to be different to their shareholdings and that certain decisions require the unanimous decision of all parties. These decisions include those concerning fundamental issues such as acquiring a new business or changing business direction, disposing of a business or entering into large financial commitments. In an agreement I prepared for a company recently, the partners required unanimous consent to employing any family members. What occurs in a deadlock situation needs to also be considered.
Exiting
Exit strategies need to be considered at the very beginning. If one of the partners only intends to be involved in the business for five years and at that time would like to sell the business than that needs to be established from the beginning. Having an exit strategy will ensure that all partners work towards the same goal. Further, the agreement should establish what should occur if one of the partners wishes to exit the partnership for any other reason. Often, there is a duty imposed on the exiting partner to offer their shares for sale to the remaining partners. In such a case, a mechanism will also be established for how the shares are valued and when settlement should occur.
Non Compete (Restraints)
Consideration need also be given to what other activities each partner may be involved in during and after the termination of the partnership. If it is expected that each partner is to be totally committed to the business venture, it will need to be agreed that no partner shall be involved in any other activity that will distract them from the needs of the business – particularly in a business that competes with the partnership business.
Similarly, should a partner exit the partnership, it should be established whether any restraints of trade are necessary to protect the good will of the partnership business for the benefit of the remaining partners. A reasonable provision ensuring that the exiting partner does not poach customers or staff of the business for a short period of time, allowing the remaining partners to regroup is appropriate.
Death or Disability
There is also the issue of death or disability of one of the partners. These issues are normally addressed in a separate agreement called a buy/sell agreement. If there is no agreement in place to deal with such an issue, the remaining partners risk being embroiled in disputes with the family or estate of the deceased or disabled partner. Often, the agreement will provide the partners with options to purchase a partner’s share should that partner die or become permanently disabled. This option is then capable of being exercised at the relevant time. Often, the partners obtain life insurance on each others’ lives, paid by the business, with the value of insurance being sufficient to cover the cost of buying the share from the deceased estate. This deals with difficulties that may arise in funding the purchase of the shares.
Joe Kafrouni, Legal Practitioner Director, Kafrouni Lawyers
Disclaimer
The information provided by Kafrouni Lawyers is intended to provide general information and is not legal advice or a substitute for it. The parties to an agreement should always consult their own legal advisors to discuss their particular circumstances. Kafrouni Lawyers makes no warranties or representations regarding the information and exclude any liability which may arise as a result of the use of this information. This information is the copyright of Kafrouni Lawyers.
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