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Double Trouble

A well-drafted agreement can keep you out of court if your partnership breaks up.
November 1, 1996

If not for the divorce, the business partners might still be together. The two men had scraped together enough money to open a small pool supply store, which they built over 20 years into a profitable chain of 65.

But suddenly things got ugly. In the throes of a divorce, one partner decided he needed cash fast. Hoping to sell his half of the company, he found a group of investors who wanted the whole business. The other partner didn't want to sell; he offered to buy his partner out for less than the partner wanted. Instead, the partner who wanted out persuaded a judge to order the partnership dissolved, the assets sold, and his former partner fired for interfering with the takeover.

Partnership disputes are nearly as common as partnerships. As the partners above learned, they often land in court. Better to avoid problems by anticipating what can go wrong and drafting a partnership agreement for all partners to sign.

Many partnerships fail to do this. In family businesses, for example, where decisions are often made informally, it's hard to imagine the tensions that plague thousands of other family businesses could ever crop up in yours. If you've just started a business, handling legal details may be far down on your list of things to do.

You may think any problems can be resolved amicably as they arise. However, partnerships wed personalities with goals and management styles that often differ markedly. One partner may want to sell out when the other doesn't have the money to buy. One may want to expand the operation dramatically, while the other would rather coast. If you agree in advance how to resolve these disputes, there's less chance a judge will have to sort it out.

Legal Underpinnings

Typically, when a business with more than one owner hasn't filed papers to form a corporation or limited liability company, courts treat it as a partnership. Partnerships in every state but Louisiana are governed by the Uniform Partnership Act, a set of laws adopted nearly 80 years ago.

The Uniform Partnership Act includes two traps for the uninformed. One concerns a partner's right to get out. Unless there's a partnership agreement to the contrary, a partner may quit or retire at any time, compelling the remaining partners to pay fair value for his or her interest. If the remaining partners don't have enough money available, they may be forced to liquidate the business.

The second trap concerns price. Although the law requires the remaining partners to pay "fair value," it doesn't specify how that value is determined. Typically, the partner who wants out expects more than the others are willing to pay. If the partners can't agree, they may have to ask a judge to set the price. Like any lawsuit, this is likely to be expensive and time-consuming. It's also unpredictable because most judges have little experience in determining the value of a partnership interest.

Avoid such problems by drafting and signing a partnership agreement that sets out how business decisions are made, how disputes are resolved and how to handle a buyout. In many cases, the process of negotiating terms helps the partners understand each other and design a structure they're all happy with.

Consult an attorney experienced with small businesses for help in drafting the agreement; a small investment at this stage can save you major headaches later. The attorney will suggest terms to consider. Here are some to get you started:

Once you negotiate and sign the partnership agreement, don't dwell on it: Put it away, and get on with your business.