Dealing With Partners: Avoiding Partnership Disputes and Preparing for a Smooth Exit

logo

Austin headshot

By Austin K. Sweet

An age-old adage states: “Friends and business don’t mix.”  The problem is that many people look for the same attributes in a business partner that they look for in a friend.  Friendships and partnerships are both built on trust, common interests, and common goals, and both tend to fail when any of those three factors diverge.  Going into business with your friends is natural and has led to some very successful enterprises as well as some epic implosions.  Properly organizing your business from the outset will help you successfully address partnership disputes in the future and avoid a scorched-earth dissolution of your business and friendship.

Formalize Your Business Relationship.  Many of the worst partnership disputes started with a handshake.  “Handshake deals” are a trial lawyer’s dream because they inevitably lead to some confusion or discrepancy.  We’ve all had that moment when we’re positive we’re right, and our spouse / friend / sibling is positive (s)he’s right.  Neither person is trying to deceive the other but someone is simply wrong.  The same thing happens in business and sometimes the stakes are much higher.  These disputes can be avoided simply by formalizing your agreements in writing.  “Handshake deals” may have been the Way of the West, but so were duels.  Avoid duels.

Another important reason to formalize your partnership is that, if you don’t, the law might do it for you.  In Nevada, legal partnerships can be created unintentionally: if two or more persons carry-on as co-owners of a business for profit, they have created a legal partnership.  Something as simple as pooling your money to buy and flip houses can create a legal partnership with a wide range of legal implications.  Formalizing your business relationship will ensure that you remain in control of your partnership without unknown and unintended legal consequences.

Address the Tough Questions Early.  Entrepreneurs are inherently optimistic people who sometimes have difficulty considering the possibility of getting into a major dispute with their friend and partner.  This can lead to some partners never discussing the uncomfortable topic of what to do when something goes wrong.

A common problem arises when a mentor offers his/her apprentice a great partnership opportunity.  Often the apprentice feels awkward addressing the mechanics of the arrangement or formalizing the relationship, fearing the mentor will take offense and withdraw the offer.  This concern is often misplaced – a good mentor will appreciate your business savvy and be encouraged that you can handle the responsibility you’ve been given.

If your partner still resists, it may be time to reconsider the business relationship.  Partners with fundamentally different views on how a business should operate cannot run a successful business.  Addressing and understanding these differences before it’s too late may save you both substantial frustration and money.

Decide How to Resolve Disputes Before they Happen.  Most business partners get along when the business starts and friends like to form 50/50 partnerships to give both partners equal rights and authority.  However, 50/50 arrangements lead to stalemates: for example, your partner wants to sell now, but you want to hold for six more months.  Absent some method to break the deadlock, this type of dispute can destroy an otherwise successful business.

Ideally, business partners should avoid 50/50 relationships altogether.  However, if you’re adamant about maintaining equal interests, establish a procedure early on for how disputes will be resolved.  It is much easier to formulate a dispute resolution plan while all parties get along than to wait for a dispute to arise.  Consider agreeing upon a mutually respected third-party (or group of people) whom is willing to informally hear both sides of your dispute and act as the tiebreaker. 

No partnership begins with disagreeable, untrusting partners, but some end with them.  Planning for disputes before they happen will save substantial grief and money.  If you don’t plan ahead, someone else (possible a judge) might end up making your decisions for you.

Formulate Multiple Exit Strategies.  All good business plans begin with an exit strategy, but things get much more complicated when partners are involved.  What if your partner wants out before you do?  Will you buy him out, or can he sell his interest to someone else?  What if you don’t have the cash to buy him out?  What if your partner dies?  Will his children inherit his interest?  If so, do you want to be partners with his children?

Including clear and detailed buy-out provisions will help you prepare for unexpected contingencies, allowing one partner to smoothly exit the partnership without ending a longtime personal friendship.  Create a “right of first refusal” to ensure that your partner’s share of the company does not get transferred to someone you do not want to do business with.  Establish a payment plan in the event that you do not have the cash available to buy-out your partner’s interest.  Be very clear about how the business will be valued and how payments will be made.

Always have a primary exit strategy and operate your business with that goal in mind.  However, preparing for the unexpected contingencies that come with adding partners to your business might save your business and your friendship down the road.

Know When Enough Is Enough.  Ugly partnership dissolutions are like bitter divorces: both parties get emotional and take unreasonably stubborn positions on objectively silly issues.  Like divorces, many of these disputes arise from minor disagreements that fester, grow, and eventually consume both sides.  If you feel this downward spiral begin, simply utilize your well-planned exit strategy and get out before irreparable damage is done, either to your business or your friendship.

Austin Sweet is an attorney at Gunderson Law Firm, practicing business law directed at helping business owners stay protected and prosper.  He can be contacted at (775) 829-1222 or asweet@gundersonlaw.com

Nevada Newsmakers With Courtney G. Forster

court

Nevada Newsmakers Tuesday, September 17, 2013

insac

Host: Sam Shad

Guest: Courtney G. Forster, Esq., Gunderson Law Firm

Pundits: Sean Cary, Vice President, Nevada Matters Media Trey Abney, Director of Government Relations, The Chamber Stacy Woodbury, President, Appearances, LLC

Inc.? Co.? P.C.? LLC?

logo

Austin headshot

By Austin K Sweet

What Type of Business to Form

Nevada is a great place to do business for a number of reasons.  Notably, Nevada has favorable tax laws and flexible corporate restrictions to encourage business men and women from across the world to form their businesses under our laws.  Unfortunately, this flexibility leads to a wide range of options, which can be overwhelming for an entrepreneur trying to decide what type of business entity is right for them.

This article outlines the legal pros and cons of the most common types of business entities to help you determine the best fit for your business.  It is important to note, however, that different business entities are taxed differently.  For more information about how taxes might affect your decision, consult with your tax advisor.

The most common reason people form business entities is for liability protection.  In general terms, some business entities shield the company’s owners from personal liability from the company’s debts.  For example, if the company enters into a contract and the company breaks that contract, the owner is not necessarily personally liable for damages.

Not all entity types offer liability protection.  Those that do are generally more expensive to form and operate and business owners are required to comply with various rules and requirements to maintain that liability protection.  However, the benefits of doing so often vastly outweigh these costs and administrative burdens.

 

Sole Proprietorship.  The most basic form for a business is a sole proprietorship.  A sole proprietorship requires no paperwork (other than necessary licensing), no filing fees, and no annual maintenance.  It is very inexpensive but offers few benefits; most importantly, sole proprietorships offer no liability protection.  Unless your business consists of selling homemade pottery on http://www.etsy.com, a sole proprietorship is probably not your best choice.

 

General Partnership.  A general partnership is essentially a multi-person sole proprietorship.  It also requires no official paperwork and offers no liability protection.  Like sole proprietorships, the primary benefit of a general partnership is that it is an inexpensive way to legally operate a business.

Be aware that general partnerships can be created unintentionally.  If you have an “informal” business venture with another person, such as co-owning a rental property, a court of law might consider that to be a legal general partnership.  This can lead to problematic and unintended legal consequences results.  If you have an “informal” business relationship with another person, it is time to formalize your partnership into a legal entity and make sure you are protected.

 

Limited-Liability Company.  A limited-liability company (“LLC”) is probably the most common form of business entity used by small businesses in Nevada.  An LLC offers its owners liability protection, but is more expensive to form and operate than a sole proprietorship or general partnership.  The terms “LLC,” “Ltd.,” and “Co.” often identify limited-liability companies.

LLCs offer the most flexible corporate structures, allowing the entity to adapt and change as your business grows.  LLCs can be simple for owner-operated small businesses, complex for large businesses with multiple owners and officers, or anything in between.  However, LLCs do not lend themselves to businesses involving numerous owners in varying capacities and levels of involvement.

The LLC’s flexibility makes it a great option for companies owned and operated by a small group of people, regardless of the company’s revenue.  An LLC is a great fit for most businesses and tends to be an appropriate “default” choice unless you need the options presented by another business entity.

 

Corporation.  Like LLCs, corporations offer their shareholders liability protection at the price of increased costs of formation and maintenance.  The terms “Inc.” and “Corp.” generally refer to a corporation.  “C Corp” and “S Corp” identify different tax designations for corporations; they do not identify different types of legal entities.

Corporations are slightly less flexible than LLCs but provide more options for complex ownership schemes.  Corporations are ideal for business owners that intend to eventually take their business public or offer their employees stock options.  Business owners seeking to bring in equity investors with any range of ownership interest and/or management control will also benefit from a corporation.

 

Professional Entities.  Professional corporations and professional limited-liability companies are available for certain professions that are prohibited from conducting business through traditional corporate forms.  For example, lawyers, accountants, doctors, and architects are some of the professions who may not seek the liability protection offered by an LLC or a corporation.

Generally speaking, a “professional” may not use a liability shield to protect himself from liability for professional negligence.  However, professionals may still seek liability protection for the non-professional debts of the company, such as breaching a lease.  Professional corporations and professional limited-liability companies allows this balance.  Aside from this restriction on the liability shield, professional corporations and professional limited-liability companies operate much like standard corporations and LLCs.

 

Other Specialty Entities.  There are a number of other business entities available in Nevada for more limited purposes.  Non-profit corporations offer excellent tax benefits, but are strictly regulated to prevent abuse.  If your business qualifies as a non-profit, the tax benefits generaly outweigh the added administrative burdens.

Limited partnerships and limited-liability partnerships offer more liability protection than general partnerships but less flexibility than LLCs or corporations.  These business types can be enticing because they are generally cheaper to form than an LLC or corporation, but their ability to adapt and change is very limited.

Whatever business type you choose, put in the time and effort at the outset to ensure that your company is organized in a way that best fits your needs.  Start-ups are already time consuming and expensive, but the organization of your business entity is a critical element that will follow your business throughout its life.  Proper planning now will save you time and money down the road.

 

Austin Sweet is an attorney at Gunderson Law Firm, practicing business law directed at helping business owners stay protected and prosper.  He can be contacted at (775) 829-1222 or asweet@gundersonlaw.com