There are any number of circumstances or sets of conditions under which it may be appropriate, advisable or necessary to bring on a partner. Regardless of the reasons for doing so, however, bringing on a partner is a major milestone for any business, often leading to expanded fields of operation, cash and capital influxes and other positive breakthroughs. It can also lead to negative consequences. Consequently, there are a few key considerations to ponder, discuss and address with your prospective new partner before you sign on the dotted line.
Bringing on a Partner – Key Issues:
Philosophy (aka the “right fit”). This should be considered part of one’s due diligence with respect to the prospective partner (and vice versa), but investigating and determining the prospect’s approach to business, money, firm culture and other aspects of the pending relationship is an important step and potential indicator of whether the relationship will be a positive one moving forward.
Structure of Partnership. This post frequently uses the words “partnership” and “partner,” but an actual partnership, in terms of the law, is considered by many, if not most, to be an outdated and outmoded form of business relationship and should generally be avoided. Seek legal and tax advice, select an entity (i.e. LLC or Inc.), form said entity and take advantage of the accompanying limited liability protection. Also seek legal and tax counsel on issuances vs. assignments, as the two may have distinct legal and tax consequences depending on your circumstances.
Price and Payment Structure. An obvious, yet important, consideration, determining how much or what the partner will pay or contribute, as well as method of payment, offers options and opportunities for partnership structures, profit and loss allocations and other incentives. A purchase price or capital contribution doesn’t necessarily have to take the form of a lump sum investment. Consider and discuss your options.
Ownership Percentages and Vesting Structure. What percentage of the company will the partner receive in exchange for his or her buy-in? Over what time frame will ownership vest? It could vest all at once, either up front or after payment of the purchase price, or it can vest in full or in portions over time. Again, seek legal and tax guidance based on the potential implications of each option.
Profit and Compensation Structure. Will profits match ownership percentages or will they vary? Will there be special terms for profits? For instance, will old business be on one profit structure and new business on another? How will salaries and other compensation be determined? The nature of the entity will play a limiting factor in this category.
Excluded Assets. Are there any assets that you would want excluded from the scope of the deal? For instance, are there any customer contracts, lines of operation or intellectual property that you want personal ownership of, instead of ownership by the entity? This may not be feasible depending on the asset at issue and the expectations of the partner. If the particular asset is fundamental to the operation of the business, it is less likely to be excludable.
Buyout or Exit Strategy. Even if all signs point to success at the outset, only time will tell if the partnership is to be fruitful. The best-laid plans…. It may be a good idea, therefore, to consider mechanisms for buying out the partner in certain circumstances.
Buy-Sell Planning. A corollary to the aforementioned buyout planning, buy-sell planning is designed to account for major life events, such as the death or disability of an owner, the institution of a bankruptcy, divorce or other court proceeding involving an owner, or the termination of an owner’s employment with the company. If one of these events occur, the Company could get dragged through legal proceedings and/or an unanticipated third party may end up owning a share of the company. Buy-sell planning incorporates mechanisms to plan for and deal with these events and avoid the potential harm to the company and each owner’s investment therein. Also consider placing more general restrictions on the ability to transfer ownership, the base line of which is typically the right of first refusal.
Control, Management and Responsibilities. Perhaps one of the most contested issues, control of the company is often a fundamental expectation of both founders and investors alike. Founding owners (understandably) may not want to give up much, if any, decision-making authority or control of the company; but, the new partner may have other ideas. Get on the same page. If you cannot, then perhaps the pending relationship is better left unfulfilled. If you can work out the control aspect, also consider the roles and responsibilities and day-to-day management rights of each owner.
Handling Conflict. Addressing conflicts and deadlock among owners is very important, particularly in a 50/50 company. Incorporating dispute resolution mechanisms is critical.
Restrictive Covenants. Do you want to include a non-compete or non-solicit agreement, the most typical restrictive covenants? These agreements could serve to protect the core of the business from unwanted competition, but could also sour a relationship at the outset. Discuss and resolve.
Other Opportunities. Perhaps you have multiple businesses, multiple location entities, or have ideas for additional business ventures. Will the new partner have the option or right to participate? Or will it be limited to one particular venture or location?
Bringing on a Partner – Plan and Communicate:
In conclusion, bringing on a partner requires careful, detailed and extensive forethought and planning. It goes without saying that proper planning is vital to offering the best chances of success when bringing on a partner. But I’ll say it anyway: proper planning is vital to offering the best chances of success when bringing on a partner. Of course, no amount of planning ensures success in business or in the relationship. Sometimes things don’t work out the way they should or the way we hope. Nonetheless, proactive planning among partners, or in this case prospective partners, is vitally important, particularly considering that it is cheaper and easier to plan for trouble than it is to get out of trouble. And to end with one final cliché: a partnership is like a marriage in that dissolution, as with divorce, is costly, time consuming and full of heartache.
Open communication is key. Discuss these issues, as well as any others you think are, with your partner to-be important (this list is not exhaustive; there may be any number of additional items to work through). The existing owner or owners may well have the leverage in a negotiation, but compromise will likely be necessary and appropriate. Fundamental expectations of the owners are both a core legal concept and the foundation of a partnership. Make sure that expectations and intentions are thoroughly addressed and give your pending partnership a stronger chance of success.
The information herein is not legal advice and does not create an attorney/client relationship. The information is in the form of legal education and is intended to provide general information about the matter. The above is not, nor is it intended to be, legal advice. Consult your attorney with questions.