June 2, 2017
The best time to prepare for the end of a business partnership is at the beginning of the relationship. There are a variety of situations in which new partners are added to a business. When partners launch a business from its inception, it is easier to determine individual rights and assets, than when partners are added to create new partnerships at different points in the history of the business. To reduce uncertainty in the event of a withdrawal of a partner, it is a good idea to identify the options for partners leaving a business in which they have assets and liabilities attributable to their time as a partner. There are several business practices, which if followed, make the changes in partnerships easier to address and less disruptive to business.
Partnership agreements, generally
As a rule, partners in a business equally share profits as well as losses. When a new partner is added or withdrawn, there is a partnership that begins and ends. There are various types of partners with different rights and duties. There are general partners and limited partners, equity partners and non-equity partners. The partnership relationship is defined in the partnership agreement and should address buy-ins, buy-outs, asset equity and debt liability. In some cases, a capital contribution required to enter a new partnership is payable over time from future profits. The accounting can be complex and it is very important to keep detailed records, conduct audits and valuations.
Why do partners withdraw from a business?
Like any relationship, there are many variables influencing the duration of an agreement to remain as partners in a business. Foreseeable life events contribute to partners withdrawing from a business when they retire, have significant changes in their personal lives, suffer from injury, disability or loss of life. Additional factors leading to the end of partnerships can be unfavorable business environments and conditions including a loss of confidence in business partners and significant differences in management opinions.
Best practices in protecting partnership interests
Partnership agreements should include maintenance requirements so that the partners know where they stand with respect to their share of assets and liabilities. Where a partnership may have significant debts, the partners should protect the partnership against loss. Insurance policies underwriting indebted partners is a good way to protect other partners from picking up the slack for a non-performing partner, or one who is disabled or loses their life.
Partnership agreements should also call for recurring accounting and reporting of individual and partnership income, assets and debt liability. Should a partner wish to part ways, there should be procedures in the agreement regarding rights of first refusals for other partners to acquire an existing partnerâ€™s interests. Partners may elect to purchase and acquire the exiting partnerâ€™s shares and interests.
A well-drafted partnership agreement can control on all the financial and legal issues that can arise when partnerships change. Of course, there can be updates in law and policy that should be considered when seasonably updating or amending partnership agreements as reasonable and necessary. For more information and ideas on custom partnership agreements, contact MKim Legal for a consultation.
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