Starting a business partnership is an exciting time, full of new challenges, shared vision and celebrations of small successes. During the good times, keeping a relationship on solid ground while running a business is easy. But what do you do when you do not agree, and the honeymoon period is over?
Whether you're discontent with the level of effort of one partner over another or you suspect your partner of outright theft and embezzlement, disputes are going to arise. Business News Daily spoke with Benjamin Pugh, an attorney and shareholder of Enterprise Counsel Group, about the issues surrounding some of the most common partnership disagreements and how to best resolve them. [Choosing a business partner? Here's what to look for.]
Like many married couples, business partners often disagree about money and how it should be allocated. Pugh says the most common dispute is when the partner controlling the money embezzles funds.
"You would be surprised how often this occurs," Pugh said. "In most partnerships, one person handles operations and another is in charge of the money. The person in charge of the money starts to do things with it that the operations partner is not aware of – inflating expenses [or] changing personal accounts to business accounts, for instance."
To combat such actions, Pugh suggests making clear ownership rules upfront. Both parties should be honest about how much time and effort they are putting into the company and agree on salaries that reflect that. Pugh also advised having the other partner approve expenses before payment is made. This keeps both partners aware of expenditures and offers the opportunity to ask questions.
While salaries and expenses are one source of income for partners, another is shareholder disbursement from the profit the business makes over the year. A less common monetary dispute is when profit disbursements for tax purposes are not made. A disbursement to at least cover each partner's tax liability should be made, and when it is not, it has negative effects on the individual's tax return. This can cause some shock and create problems between partners.
Once again, Pugh points to the ownership rules created at the start of the partnership, and notes that profit distribution should be covered in your operating agreement.
"It makes sense to keep profit and cash in the business, but not at the expense of the partners," he said. "Having it in the rules upfront takes one source of worry and possible discord away."
Your partnership may have begun with co-equal management and the partners intending to reach decisions together, but there can still be disagreements, such as one partner not carrying their weight.
"The way to start is to pursue an amicable resolution that includes being upfront with your partner," Pugh advised. "Try to come to an agreement on how to resolve this discrepancy, either through a redistribution of tasks so that level of effort is fair, or propose a higher salary to offset."
If there is no agreement, and it starts to hurt the business, there are some possible legal remedies. A partnership can be dissolved at any time by either party, wherein each side has the opportunity to buy the other one out, Pugh said. Other options include bringing in third-party investors to help with decision-making, removing a partner as an employee (but leaving them as a shareholder) or, in extreme cases, resolving the matter in court. In cases with multiple shareholders, the judge can also appoint a provisional director.
If the company is formed and based on the intellectual property of one of the partners, you can take steps to protect it against being considered company property. There should be clear documentation from the start that the individual owns the intellectual property and it is licensed to the corporation. In the event of a dispute, the company license can be revoked by the individual – again, the rules for such outlined in the agreement.
"If an individual allows the company to use the intellectual property for the business without documenting it, it can be ruled in a dispute that the intellectual property actually belongs to the company," Pugh said. "In the event a partnership ends, the person who created the IP may leave the company without it."
Proactive steps to prevent disagreements
When deciding to enter into business with a partner, it is beneficial to take actions to ensure you are going into business with a reputable and reliable individual.
"The first thing would be to do a background check on your potential partner. See if there have been any lawsuits, if he or she has a criminal record, or if there are any judgments against them." Pugh suggests hiring a private investigator if necessary.
If you are entering into a partnership with an existing, established business, make sure you see the accounting books and records. It is not unreasonable to ask to see its current facility, talk to its employees and exercise similar due diligence.
Secondly, sit down with your potential partner or partners and agree on who is in charge. This includes who makes what decisions, money distributions, ownership rules, buyout rights, rules about abandoning the business and the rights to any intellectual property.
"Make sure everyone has skin in the game and understands that 50/50 means equal effort, equal productivity," Pugh added.
Every state has different rules regarding business formation and remedies. Consulting an attorney experienced in your industry and with your state can help you establish the ground rules with your partner or partners.
Editor's note: The information presented in this article is not a substitute for professional legal advice. We strongly encourage business owners to consult an attorney to resolve partnership disputes.