Here’s the Value of a Partnership Agreement
Are you in business with someone else, or thinking about going into business with another person? Do you have a written partnership agreement or shareholders’ agreement? You should. Here’s why.
First, there are two ways that you get out of the business: you die or you leave. If you leave, you are either retiring or moving on because you no longer want to be in the business (or the others want you out). The odds of you dying or retiring from the business are far less than you leaving for other reasons. That being said, you need to plan for what happens when you exit the business, or when your business partner decides to exit.
A partnership or shareholders’ agreement should provide a mechanism for triggering an end to the relationship. A better agreement would also provide a method for valuing the business, such that there is no dispute to be had on that front either.
Often, the mechanism used is a shotgun clause. Such a clause permits the triggering party to offer to buy the other party’s interest for “$X” (or $X per share). The other party then has a choice: it has to sell its interest for that price OR it can choose to buy out the triggering party for the same price. It also works the other way around, in that the triggering party can offer to sell and the receiving party has to buy or can choose to sell. The shotgun clause forces the parties to pick a fair price.
Of course, there is a cost to creating a partnership or shareholders’ agreement. When you are setting up the business, spending more money without any immediate bang for the buck (sorry about that awful pun) is not high on the priority list. It should be.
Let me give you an example of why it is so important. In October, 2008, the Ontario Court of Appeal released a decision in a case involving a business dispute.
Carol, Peter (Carol’s husband) and Monica were optometrists. They practiced together in “partnership”. There was no proper agreement. Peter died unexpectedly in March, 2001. In December, 2001, Monica left the practice, taking equipment, customers and employees, and set up shop five kilometres away. Hello, litigation!
The parties had a trial that was heard over 29 days in 2005 and 2006. The trial judge made findings against each party, resulting in a judgment of $6,000 to Carol. The judge ordered that each side pay their own legal bills. Neither party was satisfied with the “draw” and both appealed to the Court of Appeal. The Court of Appeal dismissed each party’s appeal and ordered them to pay their own legal bills for the appeal.
Twenty-nine days of trial and an appeal! You can bet that the legal bills for each part were in the hundreds of thousands. The total of the legal bills was likely closer to $1M. The cost of partnership agreement is a dollar-store bargain in comparison. It’s a good investment.
