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Protecting the business before a partner leaves

On Behalf of | Apr 21, 2020 | Business Law

When forming a business, most people focus on what you are building – not what could change down the road. While it’s vital to cover how you’ll divide ownership duties, profit and assets as the company grows, it’s equally as important to document how the business is arranged in case it splits apart.

Even in the best partnerships, one partner may prefer a new route along the way. Whenever a partner leaves, the outcome is determined by the partnership agreement you created on formation. While the future is unpredictable, there are steps an entrepreneur can take to protect their investment from the start.

How do you plan for the “what if” scenario?

While all information in a partnership agreement is essential for business operations, there are specific details that will make separation go more smoothly. Your goal is to maintain business stability through the transition, while also meeting the demands of the partner who is leaving.

To reduce disruption when a partner leaves, a partnership agreement should include:

  • The percentage of ownership per each partner
  • The percentage of profit and loss per each partner
  • An inventory of assets provided by partners and who owns them
  • A clear definition of income versus investment per each partner
  • A manner of dispute resolution among partners
  • A procedure for the loss of a partner

The first step in any separation, is to determine a value for the loss and how that value compares to the value of the company. By including precise measurements of ownership, contributions and assets in the original agreement, you can limit disputes later.

Definitions and details are key

A partnership agreement does not just define terms for day one, but for any changes that happen throughout the journey. There are many reasons that a partner might leave. External factors, such as a family emergency or relocation can cause disruption. Other reasons may include partnership disputes, new opportunities, changing personal priorities or burnout. Whatever the reason, it impacts your business.

With each item on the list above, the goal is to clearly define the role of each partner: not just how a partner contributes, but what they earn and what they contribute to the business itself. The sticking point in most separations will concern the value attached to the partner.

What else will be affected?

When a partner leaves, it is not just about job roles and financial resources. It affects other aspects of the business too. A buyout will have tax implications that vary based on the amount of money, the inclusion of any assets (such as real estate) and even business structure. Company cash flow in the short and near term may need adjustment.

A single change within a business can cascade quickly. With foresight and proper documentation, it’s possible to control the situation, allowing the business to adapt and grow. When the partnership agreement does not include the right information, the loss of a partner can be devastating.

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