Forming a partnership is an excellent way to run a business – two minds are better than one, as they say.
However, while agreeing to build a business with someone is one thing, ensuring a robust, mutually agreed plan to mitigate potential risks is vital.
Surveys show that some 65% of startup failures are attributed to conflict between co-founders, and disputes can prove fatal for a business if its partners don’t manage them effectively. Here’s how to prevent these disputes from damaging your business.
Preventing issues through clear legal agreements
One of the most effective ways to prevent disputes in business partnerships is by having clear legal agreements in place.
These agreements serve as a roadmap for the partnership, outlining the expectations and responsibilities of each partner.
Drafting a partnership agreement
Define roles and responsibilities
Every partner should have a clear understanding of their role within the business. This includes:
- Capital contributions: How much money is each partner initially investing? Are further financial contributions expected down the line?
- Expertise: Is one partner providing specific knowledge or skills crucial to the business’s success? This could be industry-specific knowledge, technical skills or business management expertise.
- Operational support: Day-to-day responsibilities can vary widely between business partners. One partner might handle client relationships while another manages operations behind the scene. Clearly defining these roles can help prevent disputes related to workload imbalances or perceived lapses in responsibilities.
Outline profit-sharing mechanisms
Financial disputes can be particularly contentious, but you can help prevent them by:
- Clearly stating how profits and losses will be distributed. This could be an equal split based on capital contributions or another method that partners deem fair.
- Addressing potential scenarios ahead of time. For example, whether you should reinvest profits back into the business instead of distributing them among partners.
Provide mechanisms for dispute resolution
Even with clear roles and profit-sharing mechanisms, disputes can still arise. Your partnership agreement should:
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- Outline the steps to take when a disagreement occurs. This might start with internal discussions, followed by mediation and, as a last resort, arbitration or legal action.
- Specify any preferred mediators or arbitration services.
Establish procedures for adding or removing partners
As businesses grow and evolve, so do partnerships. Your agreement should:
- Detail the process for bringing in new partners, including how much they’ll invest, their roles, and their share of the profits.
- Outline the process for partners who wish to exit. This could involve instructions on whether exiting partners should sell their business shares back to the company or to the remaining partners.
Set terms for the dissolution of the partnership
Every partnership should have an exit strategy outlining the following:
- The conditions under which the partnership might end, such as the retirement of a partner, insolvency, or mutual agreement.
- Steps for winding down the business, including asset distribution and debt settlement.
Legal benefits of a formal agreement
Drawing up a formal partnership agreement isn’t just a best practice — it offers significant legal benefits.
Evidence of agreement
Having a written record of what was agreed upon can be invaluable, especially if disputes arise later.
This document can also be referred to in legal proceedings to determine the original intent of the partners.
Protection against default rules
Without a formal agreement, partnerships might inadvertently fall under the default provisions of the Partnership Act 1890. This could lead to unintended consequences, such as equal profit sharing regardless of capital contribution or roles within the business.
Clarity in financial contributions
A formal agreement can protect partners who contribute more capital or resources.
By defining profit distribution terms based on how much each partner invests in the business, you can ensure everyone receives a return on investment that aligns with their contributions.
Addressing the nuances of family businesses
Family businesses come with their own set of challenges due to the personal relationships involved.
Separate business from personal
A formal agreement helps ensure that business decisions are made based on what’s best for the company and are not influenced by interpersonal relationships or emotions.
Provide clarity on complex issues
As family businesses often involve multiple family members taking on different duties and levels of responsibility, the agreement should:
- Address potentially contentious issues, such as salaries, dividends, and the involvement of extended family members.
- Clearly define roles to prevent overlaps or imbalances in responsibilities.
Facilitate succession planning
For family businesses, continuity is often a priority. The partnership agreement should:
- Outline how leadership transitions will occur, ensuring the business’s longevity.
- Set out what will happen in future scenarios like retirement, sudden incapacitation, or the passing of a partner.
How to settle disputes when they arise
1. Review the original agreement
Start with the partnership agreement. It’s the blueprint of your partnership and likely contains instructions and provisions for handling disagreements.
2. Identify the root cause
Before addressing a dispute, understand its origins. Is it a simple misunderstanding, or is there a deeper issue at play?
3. Engage in direct negotiation
Open dialogue is often the simplest way to resolve disputes. Approach the conversation with an open mind, focusing on finding common ground.
Consider mediation
If direct talks don’t yield results, a neutral third-party mediator can help partners find an amicable resolution for all involved.
Litigation as a last resort
If mediation fails, partners might need to resort to litigation. This process can be lengthy and costly, so it’s typically seen as a last resort.
Conclusion
A successful business partnership requires effort, understanding, and clear communication. By setting clear expectations through legal agreements and proactively addressing disputes, partners can ensure their business survives and thrives.
Get in touch to discuss your business partnership.