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Partnership Agreements

Myself (Australian) and another developer (American) wish to create a partnership for a business. We would like to have some sort of contact written up to define what rights we each have in regards to the business.

We don't have the capital to spend on getting an attourney or whatever to go over the contract, so modifying an existing one would be good. Is this safe? We're pretty good friends, and we'll probably never have to reach for the contract to prove a point, it's just there as a 'better safe than sorry' thing.

Does anyone know of any existing partnership agreements, or templates, that we might modify?

Yellow Belly
Sunday, June 06, 2004

This is US law oriented, but has some good information. Search for "Partnership"

http://www.nolo.com

Tom H
Sunday, June 06, 2004

IMHO, you should look into forming a corporation. The big problem with partnerships is that you are each jointly and severally liable both to each other and to the purcahsers of your software. If, for example, you write a database tool that happens to wipe all the production data for a bank, the bank can sue and get your house.
If you form a properly-funded corporation, then if the bank sues, it gets the corporate assets, but cannot touch your personal assets.

You would have to form a C Corporation, since a US "S" Corp cannot have non-US citizens as shareholders.

My $.02

Philo

Philo
Sunday, June 06, 2004

By the way, the fact that you are good friends is exactly why you *should* have a contract.  It's always best to keep business and friendship clearly separate, even if you happen to share both.  If your friendship should happen to decay at some point, you want your business assetts to be secure.  And likewise having a contract which clearly states the terms of the business arrangement will also help preserve your friendship if the business goes down the toilet.

Joe
Sunday, June 06, 2004

Write up an agreement.  It's not because you don't trust each other or that your intentions are in any way evil.  It just spells out all of the rules, like right to purchase partners shares, what are each members rights and responsibilities, etc. 

My partnership/investment agreement for an LLC ran about $800 US for a very reputable attorney, and it is money well spent.  If you can't afford that kind of cash, you should probably reconsider your decision to go into business together (right now).

Brad
Sunday, June 06, 2004

I would back Philo here, but you might also be able to form a limited liability partnership as an alternative.

In reality there's very little difference because there's a good chance that (1) if you try to obtain any credit (bank loan / overdraft etc.) as a small limited company, then you'll be asked to sign personal guarantees on a joint and several basis [i.e. they can come after either or both of you]; and (2) [at least in the UK, I suspect in Australia and I don't know about the US] directors are agents for the companies that they manage. Thus if either of you commits the company, even to something outside its original objectives, then it can't back out. If that 'something' involves spending the bank's money, then you'll end up liable anyway.

If you plan to incorporate a company, I would take a hard look at whether it's better to do so in Australia or the U.S. and also at the tax position. I had a very rough ride with the US Internal Revenue service when I was an expat in Houston in the early 80's. Somehow (corporate cockup) I got listed as an employee of the US parent company, not the UK subsidiary, so I was harried for tax which I was damned if I was going to pay. American beaurocracy is bizarre!

Gaius
Monday, June 07, 2004

Actually, as someone who has done both the partnership and the incorporation thing with friends (not to mention seen it done) - I personally wouldn't start out incorporating.

If you incorporate, you are still going to be liable as a director.  So a determined client is going to sue anyways regardless of structure.

As soon as you open a bank account, you are likely going to have to make a personal guarantee, unless you have a very easy-going business bank (are there any these days?) or you have to wait until every one of your cheques clear completely before you can access your cash. 

So you are still going to be liable to each other and the bank.  There are advantages to incorporating, but in my opinion, liability is a red herring put up by lawyers (and ex-lawyers, Philo?) to get you to use their services. One example of a real advantage: Some clients (read: government, large companies) will not deal with partnerships, so incorporating gives you extra credibility.

Kind of like the business advisors who insist that you have to have a detailed business plan including exit strategy in order to be successful.  Which is not exactly true, because of course 'success' depends on your goals and expectations.  But I digress (and note: I'm not saying that detailed business plans or incorporating are bad ideas, just that creating a successful business is not a fill-in-the-blanks, one-size-fits-all kind of proposition)

Partnerships tend to be simpler tax-wise (you didn't mention where each of you is living) and they are easier to dissolve (trial period).  They don't have all of this artificial paperwork that is necessary in a larger organization, but comically ludicrous in a two-person show. 

That said, I concur with the others who stated that the most important time to have a partnership agreement is when you are working with someone who is close to you.  Not because you are worried about what happens if things deteriorate (happens more often than you might think), but because it helps define expectations around the relationship and prevents deterioration in the first place.  No misunderstandings about who is allowed to spend money on what, or what kind of contracts you can accept on the partnership's behalf without consultation etc.

As a bonus, if one of you gets hit by a bus or falls off a ladder while painting and can no longer work, a partnership agreement should cover what happens next, preventing your partner's kids' guardian 'Aunt Tilly' from suddenly gaining part control over your business ;)

Phibian
Monday, June 07, 2004

Being personally liable for a bank account is different than being personally liable for the actions of the partnership. That includes the actions of *either* partner. For example, let's say one partner takes out a business loan for $250k to cover "operating expenses" which he then spends on a trip around the world.

So the bank will sue the partnership and come after any partners it can find to satisfy the debt. If you have $250k in the bank, you're all set - write them a check.

In all seriousness, you need to stop giving advice that could cost people their entire livelihood. It costs less than a thousand dollars to incorporate, and a properly-funded corporation will protect its directors from personal liability.

BTW, agreed that an LLP can serve the same purpose.

Here's the Nolo article on small business structures:
http://www.nolo.com/lawcenter/ency/category.cfm/catID/19B45DBF-E85F-4A3D-950E3E07E32851A7#5DE04E60-45BB-4108-8D757E247F35B8AB

Philo

Philo
Monday, June 07, 2004

I'll second Philo on the incorporating thing.  Disparaging the power of incorporating to shield one from liability is just uninformed.

Norrick
Monday, June 07, 2004

Philo:

I thought my posting had started by agreeing with you; limited liability is useful and I would, and indeed in the 25 years I have been in business on my own account always have, taken a limited company as the starting point for considerations on business structure. I would suggest, however, that the position you set forth is not as clear cut as you make out.

Your first posting rightly points out that liability to a third party, such as your hypothetical bank, can be limited through a limited liability company. This is not, however, the only way in which such limitation can be achieved - hence my suggestion that a limited liability partnership is a viable alternative - nor, I suggest, is it the most important aspect of liability that should be consideration.

Third party, product related liability can equally be constrained through limitations imposed in a licensing agreement, which statement I qualify to exclude the possibility that failure could cause death or personal injury. I know this to be the case in the UK and, given the fact that I don't see Microsoft (or anyone else) being sued to hell in a hand basket for losses incurred consequent to bugs and virii, I feel sure must also be so in the US.

My personal opinion, however, is that your second posting is more pertinent. It flags up two critical issues. First, for most small businesses it is the liability to financial institutions that is paramount. Second, it raises the matter of liability between  co-venturers (which term I use so as not to differentiate between partners and co-shareholders in a private company).

It is a fact of life that a small, private limited company find it exceptionally hard to borrow money without security. This, as I'm sure you'll agree, inevitably means that the co-venturers, either in their role as shareholders or as directors, end up lodging joint and several personal guarantees. I appreciate that such guarantees cover only the liability to the bank, but in reality this is the principal exposure and the net result is that there is little difference between a partner and a shareholder/director who stands guarantor.

If one considers further your hypothetical case of a business loan that is misdirected (am I correct in thinking this is a real world example?), my thoughts are that a partner is in stronger position than a joint and several guarantor. Again, I qualify these remarks as being based on UK law and not necessarily applicable in the US.

There are several reasons. First, a partnership agreement is an agreement between co-venturers that regulates their behaviour with respect to the venture. The mere act of drafting it focuses the mind on what constitutes acceptable behaviour; who can spend what, when, where etc. etc. These very thoughts limit the chance that one partner can 'inadvertently' consider the round-the-world first class, five star 'sales trip' as a legitimate business expense. More importantly, if one partner does blow the bank account, then although both partners are liable to the bank for the money (and as you say, they'll go after the easier target) the innocent partner can rely directly on the partnership agreement to recover his half.

In contrast, the same situation in a private limited company is not so clear. The separation of the legal persona of the company from its shareholders and from its directors adds complexity. First, there are several more agreements that must be formulated; the Memorandum of Association, the Articles of Association, directors' agreements and shareholders' agreements. None address the interpersonal relationship between co-venturers in the same way as a partnership agreement.

In their default (statutory) form (such as you'll get buying a pre-incorporated company from a lawyer) directors have virtually unlimited power to bind the company. Shareholders, on the otherhand, cannot _individually_ bind the directors, but can only act through the company or (in exceptional circumstances) through the courts.
The net result is that if a recalcitrant director blows the company's overdraft on a first class 'sales trip', then the shareholder/ guarantor still ends up carrying the can, but has no direct means of seeking relief. In a private company spilt 50:50 between co-shareholders/ directors, neither has the voting power to force the company to act against the other for malfeasance of this sort. In a partnership each has a personal right against the other.

Furthermore, if things really take a turn for the worse, either partner can resign and automatically dissolve a partnership, any liabilities must be met, but the entire assets of the partnership are available at first call, whether or not the other partner likes it. A shareholder, on the other hand, cannot 'resign'. And a minority shareholder stuck with personal guarantee cannot at all easily force the sale of company assets to met his obligations.

To conclude, my suggestion to look at the possibilty of a limited liability partnership combines, I would suggest, the best of both worlds. The advantage of limited liability beyond any guarantees required by the bank (which come with limited liability, not with incorporation) and the tighter interpersonal liability of partnership.

This is not to say that there aren't advantages to incorporation, but these flow from a company's perpetual persona and the relative ease by which the capital structure can be altered, not exclusively from its limited liability.

I hope this clarifies my suggestion.

Gaius
Monday, June 07, 2004

Gaius, I agreed as a final comment that an LLP *is* a viable alternative. Though I will clarify that the issue is not what happens to the *company* assets - it's about personal property. Enron shows that a reckless director can ruin even a multinational corp. But those directors in Enron who didn't participate in the fraud will only lose the value of their shares - their houses and savings will never be at risk.

My most recent comment was directed at Phibian, who seems to think lawyers exist solely to line their own pockets and serve no real useful purpose.

If nothing else, I can justify this in the "other people are smarter than me" category - check with just about any entrepreneur, and I believe you'll find the first thing they do upon entering a new venture is to form a new corporation.

I'm talking about people who have made millions in private ventures.

So you gotta wonder what someone who can earn millions knows that Phibian doesn't... [grin]

Philo

Philo
Monday, June 07, 2004

I knew your comment was directed at me, although Gaius' comment was right on the money.

And actually, I never went as far as claiming lawyers exist only to feather their own nest.  I use several excellent lawyers myself, when the occasion calls for it.

As a fourth-generation entrepreneur on one side and a third-generation entrepreneur on the other, believe me when I say that I have a healthy respect for the advice of other entrepreneurs.  Not the get rich quickers who think that they can found a company, get rich and quit working (and who write a lot of magazine articles), but those of us who have taken an idea from dream to implementation and who believe that our idea is really the next best thing.

Based on my family history, my personal experience, and the experience of those around me, most entrepreneurs don't actually start out by incorporating (unless they have been reading business magazines, have been to business school, or made a lawyer their first stop into the crazy world of entrepreneurship).  Usually, we start out with an idea.  We talk about it with people.  Sometimes we line up customers, an initial product.  Then we test out the market.  We sell things as sole proprietorships or partnerships, because we aren't business people first - we are inventors, techies, producers of something valuable.  We are cheap.  Usually we are bootstrapping our idea(s) on our savings, day job, credit card debt, family and friend generosity, while pitching it to everyone we meet.  Sometimes we get an extra boost with VC money, but unless we have read a few too many magazines, we tend share Joel's opinion on VC money.

Sure, not all of the people I know have made millions in private ventures (so what?  Entrepreneurship is a lifestyle, something in the blood, not the winning lottery ticket).  Some have, some 'merely' earn a living, others ducked back into employee life.  In fact, I have close personal knowledge of the bankruptcy process - my father has reason to know that even the protection of directorship is not sufficient to avoid losing your house and savings when the corporation is basically you, mainly due to the personal guarantee issue.  Yes, it does provide some protection, but it makes me crazy to hear non-entrepreneurial lawyers (often working for big firms) talk about incorporation as if it is a magic bullet.

If you've never been on this side of the fence, then don't talk to me about the potential of losing your entire livelihood. 

My point wasn't that incorporation is bad (remember, I stated at the beginning of my post that I am incorporated...), just that I wouldn't start there because it is expensive (we spend at least an extra $1000/year due to extra paperwork fees), costs ongoing time you could spend on billable stuff, and doesn't actually provide as much protection as many lawyers try to make out.

Re: your partner that takes off with your $250,000 bank account, I would say that you've already got serious problems if this can even happen.  In addition to a detailed partnership agreement, dual signatures on your checks are a very good idea (tm).

Re: Enron.  The problem with business magazines, courses etc etc is that they lump all kinds of businesses together.  Enron was a huge company, the OP is forming a small partnership with some other guy he knows.  Being a director of Enron has very little in common with being a director of a very small corporation.  For starters, many of the directors were members of the board 'part time'.  When Enron went belly-up, their main source of income didn't necessarily dry up.  Nor had they spent most (all) of their savings to prop up their faltering business.  I doubt any (and certainly not all) even had to give a personal guarantee for anything - banks are happy to deal with a large account like Enron.  It's not considered nearly as risky.

Phibian
Tuesday, June 08, 2004

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