New business owners have dozens of things to spend money on and will often skip over some of the things they don’t think they’ll need. Consider this case of two best friends who decide to open a business together.
Bob and Joe have been best friends for 10+ years. Bob is married and his wife stays home to care for their two young children. Joe is a widower with three grown children.
They decide to join forces and open a sandwich shop. They’ll put in an equal amount of cash to start it and then split the profits and expenses equally.
They use an accountant to create an LLC but they don’t involve an attorney to create a partnership document. They trust one another completely, so they see it as unnecessary.
Over the years the business grows from one sandwich shop to five. Bob and Joe lived comfortably on the proceeds from their partnership.
The Unexpected Happens
Ten years later, Joe becomes ill suddenly and dies. Joe’s three children let Bob know they’ll be sharing Joe’s 50% stake. Now Bob has three partners he doesn’t know or agree with, instead of one partner he trusted implicitly. The business suffers as the siblings disagree among themselves, and as Bob disagrees with his inexperienced partners.
This is not what Bob wants, so he reaches out to Daniel Denton of Herbert Legal Group in Roswell.
Dan’s first request was for a copy of the original partnership agreement. Bob reluctantly admitted they’d never had one, and had never felt the need to create a legal document when things were fine between them.
Dan explained that, without a legal agreement between Bob and Joe, Joe’s children really did own half of Bob’s business.
Dan offered two options: a partnership agreement Bob and Joe’s children, or buying Joe’s share from his children. Bob decided to buy them out.
How to Avoid the Gotcha
A partnership or operating agreement is crucial for a partnership, no matter how close the partners might be. A basic agreement includes:
- The roles each partner holds
- How financial decisions will be made
- How employees will be treated
- Structure for a buy-out
- How to split the business between the partners
- A 50/50 split is not the ideal solution because partners can deadlock. An alternative is 51/49 with the 49% partner getting a larger distribution.
These are complex decisions and should be done with the guidance of an attorney. In the case of Bob and Joe’s simple and straightforward partnership, the cost of the agreement would have been around $1,200 — a small price to pay to avoid the uncertainty Bob faced after Joe’s death.
Thanks to Daniel Denton for sharing his experience with me.
Cheryl Blazej has been providing no-nonsense back-office bookkeeping and support to entrepreneurs since 2006. In the course of her work, she has encountered business management questions that are shared by many entrepreneurs, and she publishes the results of her research and experience here.