What You Need to Know about Partnership Agreements

What You Need to Know about Partnership Agreements

What happens if business partners need to split? What if they need to sell? How can partners maintain control of a company as people get married, divorced, or pass away?

These are serious questions that are a reality for many business partnerships. Before we jump in, let’s review three core concepts that you’ll need to know if you’re going into a business partnership: buy-sell provisions, voting versus economic interest, and voluntary versus involuntary transfers.

One of the most important considerations to include in a partnership agreement is a “Buy-Sell Provision:”

Buy-sell provisions allow partners to control where the ownership of the partnership would go should certain contingencies — death, divorce, or bankruptcy — take place.

Most states, including Maryland, have a concept called “pick-your-partner.” Pick-your-partner simply means that the owners of any business have the right to determine how other people become owners of the company. To make any partnership a “pick-your-partner” arrangement, the partnership agreement should include restriction on transfer of ownership that give the partners the right to determine who, what, when, and, how other people will become owners of the business. These restrictions, however, require pre-planning before the crisis hits and must be included in a partnership agreement. Here is where a buy-sell provision comes in hand.

One of the most common things to do is have a provision in the partnership agreement that says no partner can sell or transfer any ownership shares unless it is in line with the partnership agreement). Indicating what happens in the case of death, divorce, or bankruptcy is critical.

When it comes to a party’s interests, you’ll want to consider voting interest versus economic interest.

Voting interest is the right to conduct or manage the operations of a business as a partner or member.

Economic interest is the right to receive profits, distributions, or dividends from the business.

While for the most part I talk about partnership as either a general partnership, an LLC, or a corporation with just a few stockholders, this is one area where differences among the forms exist. In a partnership and an LLC, it is possible to separate the voting interest from the economic interest. So, a person (say a deceased partner’s spouse) can receive the economic interest of profit distributions, but have no right to manage or vote in business decisions. In a corporation however, particularly small corporations with a few stockholders, the ownership of stock includes both voting and economic interests represented by the stock.

Another concept you’ll want to know is voluntary versus involuntary transfers.

A voluntary transfer is just that: a partner or member is interested in transferring their shares to someone else. 

On the contrary, involuntary transfers are when a partner is forced to let go of their shares, most commonly in cases of bankruptcy, death, or divorce.

The buy-sell provisions must acknowledge what would happen in the case of bankruptcy, death, or divorce. Just because partners like your spouse, family, and friends, that does not mean that they want to be in business with them.

Partnership agreements are a huge investment of time and tend to get complicated. Familiarize yourself with these key concepts and you’ll make it through (with the support of a great attorney). Stay tuned for our upcoming posts on partnership agreements and these key concepts. As always, contact us should you have any questions.